Stock Prices and Monetary Policy Shocks: A General Equilibrium Approach

30 Pages Posted: 19 May 2011

See all articles by Edouard Challe

Edouard Challe

Ecole Polytechnique

Chryssi Giannitsarou

University of Cambridge - Faculty of Economics; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: May 2011

Abstract

Recent empirical literature documents that unexpected changes in the nominal interest rates have a significant effect on stock prices: a 25-basis point increase in the Fed funds rate is associated with an immediate decrease in broad stock indices that may range from 0.5 to 2.3 percent, followed by a gradual decay as stock prices revert towards their long-run expected value. In this paper, we assess the ability of a general equilibrium New Keynesian asset-pricing model to account for these facts. The model we consider allows for staggered price and wage setting, as well as time-varying risk aversion through habit formation. We find that the model predicts a stock market response to policy shocks that matches empirical estimates, both qualitatively and quantitatively. Our findings are robust to a range of variations and parameterizations of the model.

Keywords: Asset prices, Monetary policy, New Keynesian general equilibrium model

JEL Classification: E31, E52, G12

Suggested Citation

Challe, Edouard and Giannitsarou, Chryssi, Stock Prices and Monetary Policy Shocks: A General Equilibrium Approach (May 2011). CEPR Discussion Paper No. DP8387. Available at SSRN: https://ssrn.com/abstract=1846289

Edouard Challe (Contact Author)

Ecole Polytechnique ( email )

Ecole Polytechnique
Department of Economics
Paris, 75005
France

Chryssi Giannitsarou

University of Cambridge - Faculty of Economics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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