Monetary Policy Drivers of Bond and Equity Risks
John Y. Campbell
Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
Carolin E. Pflueger
University of British Columbia (UBC) - Division of Finance
Luis M. Viceira
Harvard Business School - Finance Unit; National Bureau of Economic Research (NBER)
June 15, 2015
Harvard Business School Finance Working Paper No. 14-031
How do monetary policy rules, monetary policy uncertainty, and macroeconomic shocks affect the risk properties of US Treasury bonds? The exposure of US Treasury bonds to the stock market has moved considerably over time. While it was slightly positive on average over the period 1960-2011, it was unusually high in the 1980s, and negative in the 2000s, a period during which Treasury bonds enabled investors to hedge macroeconomic risks. This paper develops a New Keynesian macroeconomic model with habit formation preferences that prices both bonds and stocks. The model attributes the increase in bond risks in the 1980s to a shift towards strongly anti-inflationary monetary policy, while the decrease in bond risks after 2000 is attributed to a renewed focus on output fluctuations, and a shift from transitory to persistent monetary policy shocks. Endogenous responses of bond risk premia amplify these effects of monetary policy on bond risks.
Number of Pages in PDF File: 70
Date posted: September 29, 2013 ; Last revised: June 16, 2015
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