Monetary Policy Drivers of Bond and Equity Risks

70 Pages Posted: 29 Sep 2013 Last revised: 16 Jun 2015

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)

Multiple version iconThere are 3 versions of this paper

Date Written: June 15, 2015

Abstract

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.

Suggested Citation

Campbell, John Y. and Pflueger, Carolin E. and Viceira, Luis M., Monetary Policy Drivers of Bond and Equity Risks (June 15, 2015). Harvard Business School Finance Working Paper No. 14-031. Available at SSRN: https://ssrn.com/abstract=2332106 or http://dx.doi.org/10.2139/ssrn.2332106

John Y. Campbell

Harvard University - Department of Economics ( email )

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HOME PAGE: http://scholar.harvard.edu/campbell

National Bureau of Economic Research (NBER)

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Carolin E. Pflueger

University of British Columbia (UBC) - Division of Finance ( email )

2053 Main Mall
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Canada

Luis M. Viceira (Contact Author)

Harvard Business School - Finance Unit ( email )

Boston, MA 02163
United States
617-495-6331 (Phone)
617-496-6592 (Fax)

HOME PAGE: http://www.people.hbs.edu/lviceira

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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