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Asset Prices and Assymetries in the Fed's Interest Rate Rule: a Financial Approach

Katarzyna Romaniuk () and Radu Vranceanu ()
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Katarzyna Romaniuk: University of Paris 1 Panthéon-Sorbonne, PRISM, Postal: 1, rue Victor Cousin, 75005 PARIS, FRANCE

No DR 08006, ESSEC Working Papers from ESSEC Research Center, ESSEC Business School

Abstract: Financial Newspapers have for long suggested that the Fed tends to provide additional Liquidity when the Stock Market thumbs. We provide a theoretical Explanation for this Behaviour that builds on the Methodology developed by Romaniuk (2008) for a central Banker with two main Goals, Output and Price stability. In this Paper, the Policymaker behaves as a Portfolio Manager who aims at stabilizing Output, Goods Prices, as well as Asset Prices. An optimal, Time-varying Interest Rate Rule is obtained as the Merton's (1971) continuous Time Solution to the Portfolio Manager's Problem. In a second Step, we infer the optimal Interest Rate Rule of a central Bank that can react differently to positive and negative Variations in the Stock Market.

Keywords: Optimal Interest Rate Rule; Portfolio Choice; Fed; Asset Prices; Options Theory (search for similar items in EconPapers)
JEL-codes: C61 E58 G11 (search for similar items in EconPapers)
Pages: 16 pages
Date: 2008-03
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-ore
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