Portfolio Inertia and the Equity Premium

41 Pages Posted: 17 Nov 2009

See all articles by Christopher J. Gust

Christopher J. Gust

Federal Reserve Board - Trade and Financial Studies

David Lopez-Salido

Board of Governors of the Federal Reserve System

Date Written: November 16, 2009

Abstract

We develop a DSGE model in which aggregate shocks induce endogenous movements in risk. The key feature of our model is that households rebalance their financial portfolio allocations infrequently, as they face a fixed cost of transferring cash across accounts. We show that the model can account for the mean returns on equity and the risk-free rate, and generates countercyclical movements in the equity premium that help explain the response of stock prices to monetary shocks. The model is consistent with empirical evidence documenting that unanticipated changes in monetary policy have important effects on equity prices through changes in risk.

Keywords: Limited financial market participation, infrequent portfolio adjustment, equity premium

JEL Classification: E32, E44

Suggested Citation

Gust, Christopher J. and Lopez-Salido, David, Portfolio Inertia and the Equity Premium (November 16, 2009). FRB International Finance Discussion Paper No. 984. Available at SSRN: https://ssrn.com/abstract=1507285 or http://dx.doi.org/10.2139/ssrn.1507285

Christopher J. Gust (Contact Author)

Federal Reserve Board - Trade and Financial Studies ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States

David Lopez-Salido

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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