Essays on Monetary Policy and Asset Prices

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2018

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Abstract

My Ph.D. dissertation is composed of two chapters studying how monetary policy influences asset prices.

The first chapter empirically explores the effects of the Federal Reserve (Fed)'s large-scale asset purchasing (LSAP) program on the cross-section of equity returns through financial intermediaries' funding liquidity. Using the LSAP shock by Swanson (2017) as a policy measure and the Liquidity Mismatch Index by Bai et al. (2017) as a funding liquidity measure of intermediaries, I show that an expansionary policy shock increases the stock return of banks with low liquidity more than those with high liquidity. In addition, the liquidity of lenders also influences their borrowers' equity prices through their sticky loan contracts. Firms borrowing from low liquidity banks, and of high loan-to-asset ratio earn relatively higher returns under the same expansionary shock. The response of borrowers is weaker, more delayed, and more persistent than that of lenders. These findings collectively provide supportive evidence of the bank lending channel as a policy transmission mechanism in the quantitative easing period.

The second chapter theoretically analyzes how monetary policy feedback rule can influence the risk premium of financial assets in a New Keynesian general equilibrium model where a firm's default is endogenously determined from the limited liability of stockholders, and nominal price and wage rigidity exist. A productivity (monetary policy) shock shifts supply (demand) curve, causing output comove positively (negatively) with inflation. A policy rule to output and inflation determines the magnitude of output response to those shocks, determining the price of risk and the procyclicality of dividend. Higher (lower) inflation and lower (lower) output feedback lead to higher equity premium driven by a productivity (policy) risk. This trend is robust to the source of nominal rigidity. Under a baseline calibration, the model generates 1.76% (1.87%) of the annual levered (unlevered) equity risk premium, indicating an endogenous leverage does not amplify the equity return. The countercyclicality of the default rate in the model generates a credit risk premium, but does not amplify the overall credit spread. Producing reasonable asset pricing dynamics based on New Keynesian production-based models remains challenge.

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Oh, Tae-Rog (2018). Essays on Monetary Policy and Asset Prices. Dissertation, Duke University. Retrieved from https://hdl.handle.net/10161/17438.

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