Nominal Rigidities and the Term Structures of Equity and Bond Returns
44 Pages Posted: 5 Jul 2015 Last revised: 24 Jul 2015
Date Written: June 30, 2015
A downward-sloping term structure of equity and upward-sloping term structures of interest rates arise endogenously in a general-equilibrium model with nominal rigidities and nonlinear habits in consumption. Countercyclical marginal costs exacerbate the procyclicality of dividends after a technology shock, and hence their riskiness, and generate countercyclical inflation. Marginal costs gradually fall after a negative technology shock as the price level increases sluggishly, so the payoffs of short-duration dividend claims (bonds) are more (less) procyclical than the payoffs of long-duration claims (bonds). The simultaneous presence of market and home consumption habits allows for uniting nonlinear habits and a production economy without compromising the ability of the model to fit macroeconomic variables.
Keywords: Structural term structure modeling, Equity and bond yields, Habit formation, Nominal rigidities
JEL Classification: E43, E44, G12
Suggested Citation: Suggested Citation