Asset Pricing Implications of a New Keynesian Model

63 Pages Posted: 22 Aug 2007 Last revised: 15 Jul 2009

See all articles by Bianca De Paoli

Bianca De Paoli

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP)

Alasdair M. Scott

International Monetary Fund (IMF)

Olaf Weeken

Bank of England - Monetary Analysis

Date Written: June 1, 2007

Abstract

To match the stylised facts of goods and labour markets, the canonical New Keynesian model augments the optimising neoclassical growth model with nominal and real rigidities. We ask what the implications of this type of model are for asset prices. Using a second-order approximation, we examine bond and equity returns, the equity risk premium, and the behaviour of the real and nominal term structure. We catalogue the factors that are most important for determining the size of risk premia and the slope and level of the yield curve. In a world of technology shocks only, increasing the degree of real rigidities raises risk premia and increasing nominal rigidities reduces risk premia. In a world of monetary policy shocks only, both real and nominal rigidities raise risk premia. The results indicate that the implications of the New Keynesian model for average asset returns depend critically on the characterisation of shocks hitting the model economy.

Keywords: Asset prices, New Keynesian, rigidities

Suggested Citation

De Paoli, Bianca and Scott, Alasdair M. and Weeken, Olaf, Asset Pricing Implications of a New Keynesian Model (June 1, 2007). Bank of England Working Paper No. 326, Available at SSRN: https://ssrn.com/abstract=1008853 or http://dx.doi.org/10.2139/ssrn.1008853

Bianca De Paoli (Contact Author)

London School of Economics & Political Science (LSE) - Centre for Economic Performance (CEP) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Alasdair M. Scott

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Olaf Weeken

Bank of England - Monetary Analysis ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom

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