Working Paper | HBS Working Paper Series | 2014

Monetary Policy Drivers of Bond and Equity Risks

by John Y. Campbell, Carolin E. Pflueger and Luis M. Viceira


The exposure of U.S. Treasury bonds to the stock market has moved considerably over time. While it was slightly positive on average in the period 1960–2011, it was unusually high in the 1980s and negative in the 2000s, a period during which Treasury bonds enabled investors to hedge macroeconomic risks. This paper explores the effects of monetary policy parameters and macroeconomic shocks on nominal bond risks, using a New Keynesian model with habit formation and discrete regime shifts in 1979 and 1997. The increase in bond risks after 1979 is attributed primarily to a shift in monetary policy towards a more anti-inflationary stance, while the more recent decrease in bond risks after 1997 is attributed primarily to a renewed emphasis on output stabilization and an increase in the persistence of monetary policy. Endogenous responses of bond risk premia amplify these effects of monetary policy on bond risks.

Keywords: Risk and Uncertainty; Bonds; Central Banking; System Shocks; Policy; Macroeconomics;


Campbell, John Y., Carolin E. Pflueger, and Luis M. Viceira. "Monetary Policy Drivers of Bond and Equity Risks." Harvard Business School Working Paper, No. 14-031, September 2013. (Revised April 2014.)