Nominal Rigidities and the Term Structures of Equity and Bond Returns

López-Salido, J. David; Vazquez-Grande, Francisco; dup Lopez, Pier

Working Paper

Nominal Rigidities and the Term Structures of Equity and Bond Returns

Abstract: 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.

Keywords: Equity and bond yields; habit formation; nominal rigidities; structural term structure modeling;

JEL Classification: E43; E44; G12;