Portfolio Balance Effects and the Equity Market
32 Pages Posted: 29 Oct 2015
Date Written: October 27, 2015
Many monetary studies on the portfolio balance effect omit its impact to equity returns. Motivated through a simple general equilibrium model, we study how changes in the bond supply affect the overall equity market. Our model predicts that exogenous increases (decreases) in the bond supply coincide with a lower (higher) equity price, all else equal. A historical investigation from 1952-2014 discovers asymmetric effects, both leading to higher equity prices. While the portfolio balance channel explains how unexpected downward shifts in the bond supply lead to higher equity prices, empirical evidence suggests unexpected upward shifts coincide with higher inflation.
Keywords: Quantitative easing, portfolio balance channel, equity risk premium
JEL Classification: E43, E52, G11, G12
Suggested Citation: Suggested Citation