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Real Risk-Free Rate, the Central Bank, and Stock Market Bubbles

Author

Listed:
  • Jukka Ilomäki

    (Faculty of Management, FI-33014 University of Tampere, Finland)

  • Hannu Laurila

Abstract

The central bank acts as a social planner, and adjusts the real risk-free rate of return to correct any mispricing in the stock market so that the emergence of positive or negative bubbles is avoided. The analysis shows that the central bank must raise the risk-free rate in the case of a positive bubble, and vice versa. Moreover, the central bank should intervene in the stock market even if it does not have perfect information about the bubble. This is because the sequential dividend yields in the pricing equations are stationary. Thus, even the delayed reaction of the central bank prevents the fundamental value and the equilibrium price from drifting apart for extended periods.

Suggested Citation

  • Jukka Ilomäki & Hannu Laurila, 2017. "Real Risk-Free Rate, the Central Bank, and Stock Market Bubbles," Journal of Reviews on Global Economics, Lifescience Global, vol. 6, pages 420-425.
    • Handle: RePEc:lif:jrgelg:v:6:y:2017:p:420-425
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    File URL: http://www.lifescienceglobal.com/independent-journals/journal-of-reviews-on-global-economics/volume-6/85-abstract/jrge/2916-abstract-real-risk-free-rate-the-central-bank-and-stock-market-bubbles
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    Citations

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    Cited by:

    1. Ilomaki Jukka & Laurila Hannu, 2017. "Stock Market Dynamics and the Central Bank in a General Equilibrium Model," Working Papers 1715, Tampere University, Faculty of Management and Business, Economics.
    2. Jukka Ilomäki & Hannu Laurila, 2021. "Leaning against the wind policy and animal spirits in a general equilibrium model," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(2), pages 2325-2334, April.

    More about this item

    Keywords

    Real Interest Rate; Monetary Policy; Portfolio Choice.;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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