XXV Edition

1-2 December 2016"

Nominal Rigidities and the Term Structures of Equity and Bond Returns

Vazquez-Grande Francisco, Federal Reserve Board
Lopez Pierlauro, Bank of France

A downward-sloping term structure of equity and upward-sloping term structures of interest rates arise endogenously in a general-equilibrium model with nominal rigidities and nonlinear habits in consumption. Countercyclical marginal costs exacerbate the procyclicality of dividends after a technology shock, and hence their riskiness, and generate countercyclical inflation. Marginal costs gradually fall after a negative technology shock as the price level increases sluggishly, so the payoffs of short-duration dividend claims (bonds) are more (less) procyclical than the payoffs of long-duration claims (bonds). The simultaneous presence of market and home consumption habits allows for uniting nonlinear habits and a production economy without compromising the ability of the model to fit macroeconomic variables.

Area: Asset Pricing and Derivatives

Keywords: Structural term structure modeling, Equity and bond yields, Habit formation, Nominal rigidities

Paper file

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