August 2015

Nominal Rigidities and the Term Structures of Equity and Bond Returns

Pier Lopez, David Lopez-Salido, and Francisco Vazquez-Grande


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.

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


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Last Update: June 19, 2020