The Impact of Monetary Policy on Bond Returns: A Segmented Markets Approach

Rutgers University Economics Working Paper No. 2004-02

19 Pages Posted: 10 Aug 2004

See all articles by Bruce Mizrach

Bruce Mizrach

Rutgers University, Department of Economics

Filippo Occhino

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Date Written: July 2004

Abstract

This paper assesses the contribution of monetary policy to the dynamics of bond real returns. We assume that the monetary authority controls the short-term nominal interest rate. We then model exogenously the joint dynamics of the aggregate endowment and the monetary policy variable, and determine bond real returns endogenously. Market segmentation is introduced by permanently excluding a fraction of households from financial markets. When markets are segmented, monetary policy has a direct liquidity effect on the participants' consumption and marginal utility, on the stochastic discount factor, and on real returns. With full participation, however, real returns are determined by the aggregate endowment only, so monetary policy can affect them only indirectly. Data on bond returns strongly favor the segmented markets model over the full participation model. For maturities up to 2 years, the segmented markets model is able to replicate the sign and the size of the impulse response of bond returns to monetary policy shocks, it correctly predicts the sign of their autocorrelation, and it closely matches their volatility as a function of maturity.

Keywords: Bond returns volatility, limited participation, segmented markets, monetary policy shocks

JEL Classification: E44, E52, G12

Suggested Citation

Mizrach, Bruce and Occhino, Filippo, The Impact of Monetary Policy on Bond Returns: A Segmented Markets Approach (July 2004). Rutgers University Economics Working Paper No. 2004-02. Available at SSRN: https://ssrn.com/abstract=574124 or http://dx.doi.org/10.2139/ssrn.574124

Bruce Mizrach (Contact Author)

Rutgers University, Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States
(848) 932-8636 (Phone)
(732) 932-7416 (Fax)

HOME PAGE: http://snde.rutgers.edu/

Filippo Occhino

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
159
Abstract Views
1,179
rank
195,321
PlumX Metrics