Speaker: Carina Fleischer, Goethe University Frankfurt
Title: Can Inflation and Monetary Policy Predict Asset Prices?
Abstract: We develop a continuous-time endowment economy model of the US with inflation and the central bank’s interest rate adjustments as observable risk factors. We show that they have predictive power for consumption growth and can explain many features of the aggregate stock and bond market. We derive the price-dividend ratio, the equity premium, the risk-free rate, and the term structure of interest rates. We show in a calibrated model that inflation and the federal funds rate adequately predict those key asset pricing moments. The model offers a novel mechanism to explain the variation in the aggregate price-dividend ratio and the risk-free rate as it relies on observable rather than latent risk factors.