Monetary Policy Rules and the Equity Premium in a Segmented Markets Model

53 Pages Posted: 12 Oct 2021 Last revised: 4 Mar 2024

See all articles by Yulei Peng

Yulei Peng

Sun Yat-sen University (SYSU) - Lingnan (University) College

Anastasia Zervou

University of Texas at Austin

Date Written: June 18, 2022

Abstract

We study the effect of different monetary policy rules on stock and bond risk using a segmented financial market model. The optimal monetary policy rule in our model is risk-sharing and countercyclical after shocks in the financial markets. Under that policy, equity is not risky, and its return is low. The optimal policy, however, implies inflation risk and thus high return for nominal bonds. On the other hand, under inflation targeting, there is no insurance against financial income risk and the equity return is high. At the same time, inflation targeting insures against inflation, resulting in nominal bonds becoming attractive assets. Our model suggests that monetary policy objectives play a key role in affecting risk sharing, asset returns, and the equity premium.

Keywords: Risk-sharing, Segmented financial markets, Asset prices

JEL Classification: E44, E52, G12

Suggested Citation

Peng, Yulei and Zervou, Anastasia, Monetary Policy Rules and the Equity Premium in a Segmented Markets Model (June 18, 2022). Available at SSRN: https://ssrn.com/abstract=3940342 or http://dx.doi.org/10.2139/ssrn.3940342

Yulei Peng

Sun Yat-sen University (SYSU) - Lingnan (University) College ( email )

135 Xingang Xi Road
Tuen Mun
Guangzhou, Guangzhou 510275
China

Anastasia Zervou (Contact Author)

University of Texas at Austin ( email )

6906 N Loop 1604 W
San Antonio, TX Texas 78249
United States

HOME PAGE: http://https://liberalarts.utexas.edu/economics/faculty/az7379

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