Why Does the Fed Move Markets so Much? A Model of Monetary Policy and Time-Varying Risk Aversion / Carolin Pflueger, Gianluca Rinaldi.

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Pflueger, Carolin

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w27856.Publication details: Cambridge, Mass. National Bureau of Economic Research 2020.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: We build a new model integrating a work-horse New Keynesian model with investor risk aversion that moves with the business cycle. We show that the same habit preferences that explain the equity volatility puzzle in quarterly data also naturally explain the large high-frequency stock response to Federal Funds rate surprises. In the model, a surprise increase in the short-term interest rate lowers output and consumption relative to habit, thereby raising risk aversion and amplifying the fall in stocks. The model explains the positive correlation between changes in breakeven inflation and stock returns around monetary policy announcements with long-term inflation news.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
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September 2020.

We build a new model integrating a work-horse New Keynesian model with investor risk aversion that moves with the business cycle. We show that the same habit preferences that explain the equity volatility puzzle in quarterly data also naturally explain the large high-frequency stock response to Federal Funds rate surprises. In the model, a surprise increase in the short-term interest rate lowers output and consumption relative to habit, thereby raising risk aversion and amplifying the fall in stocks. The model explains the positive correlation between changes in breakeven inflation and stock returns around monetary policy announcements with long-term inflation news.