Why Does the Fed Move Markets so Much? A Model of Monetary Policy and Time-Varying Risk Aversion
Year: 2020
Type: report
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 highfrequency 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.
DOI: 10.3386/w27856
Authors: Carolin Pflueger, Gianluca Rinaldi
Language: English
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W3088043368