Portfolio inertia and the equity premium

By Christopher Gust and David López-Salido

http://d.repec.org/n?u=RePEc:fip:fedgif:984&r=dge

We develop a DSGE model in which aggregate shocks induce endogenous movements in risk. The key feature of our model is that households rebalance their financial portfolio allocations infrequently, as they face a fixed cost of transferring cash across accounts. We show that the model can account for the mean returns on equity and the risk-free rate, and generates countercyclical movements in the equity premium that help explain the response of stock prices to monetary shocks. The model is consistent with empirical evidence documenting that unanticipated changes in monetary policy have important effects on equity prices through changes in risk.

Yet another attempt to solve the equity premium puzzle while obtaining a reasonable risk free rate. So many explanation have been thrown at the wall, finally a explanation that will stick?

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One Response to Portfolio inertia and the equity premium

  1. M.H. says:

    Is there a paper out there that put all the various explanations for the equity premium puzzle into a single model and checked whether together they can explain the puzzle?

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