Monetary Policy Rules and the Equity Premium

Yulei Peng and Anastasia Zervou
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Yulei Peng: Lingnan (University) College

No 20141115_001, Working Papers from Texas A&M University, Department of Economics

Abstract: We study the effect of monetary policy on the equity premium using a segmented stock market model. Optimal monetary policy in our model involves risk-sharing and is countercyclical with respect to dividend shocks; thus, it implies low equity return compared to other policies, including inflation targeting. The optimal policy, however, does not guarantee inflation stability and produces higher nominal bond return compared to inflation targeting. Our calibration exercise finds equity premium of 7% under the inflation targeting policy and 1.5% under the optimal policy. We suggest that suboptimal policies focusing on inflation stability might result in high equity premia.

Keywords: Equity premium; Monetary policy; Segmented financial markets (search for similar items in EconPapers)
JEL-codes: E44 E52 G12 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2014-11-15
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Related works:
Working Paper: Monetary Policy Rules and the Equity Premium (2016)
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