Why Does the Fed Move Markets so Much? A Model of Monetary Policy and Time-Varying Risk Aversion
We build a new model integrating a work-horse New Keynesian model with investor risk aversion that moves with the business cycle. We show that the same habit preferences that explain the equity volatility puzzle in quarterly data also naturally explain the large high-frequency stock response to Fede...
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| creator | Pflueger, Carolin Rinaldi, Gianluca |
| description | We build a new model integrating a work-horse New Keynesian model with investor risk aversion that moves with the business cycle. We show that the same habit preferences that explain the equity volatility puzzle in quarterly data also naturally explain the large high-frequency stock response to Federal Funds rate surprises. In the model, a surprise increase in the short-term interest rate lowers output and consumption relative to habit, thereby raising risk aversion and amplifying the fall in stocks. The model explains the positive correlation between changes in breakeven inflation and stock returns around monetary policy announcements with long-term inflation news. |
| doi_str_mv | 10.3386/w27856 |
| format | Article |
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| identifier | ISSN: 0898-2937 |
| ispartof | NBER Working Paper Series, 2020-09 |
| issn | 0898-2937 |
| language | eng |
| recordid | cdi_proquest_journals_2649431768 |
| source | National Bureau of Economic Research Publications; Alma/SFX Local Collection |
| subjects | Asset Pricing Consumption Economic theory Federal funding Federal funds rate Federal Reserve monetary policy Inflation Interest rates Monetary Economics Monetary policy Phillips curve Securities markets Stock exchanges |
| title | Why Does the Fed Move Markets so Much? A Model of Monetary Policy and Time-Varying Risk Aversion |
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