70 Pages Posted: 29 Sep 2013 Last revised: 16 Jun 2015
Date Written: June 15, 2015
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: 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