The role of asset prices in transmitting monetary and other shocks

In this paper framework is constructed within which the ability of asset prices to convey information about the underlying shocks hitting the economy can be assessed. An identified VAR is used to establish a set of stylised facts as to how asset prices respond to exogenous monetary policy movements. A theoretical model of the economy is then developed, and used to analyse how asset prices modelled within it respond to different shocks. Consumers in the model consume both market-produced and home-produced goods. There are two types of firms: those producing traded goods sold on competitive world markets and those producing non-traded goods. Non-traded goods producers face costs of adjusting their capital stocks and can only reset their prices once a year in a staggered fashion. It is shown that the model is able to replicate the stylised facts found in the empirical exercise. It is then shown how asset prices respond to shocks to productivity in the traded, non-traded and household production sectors and a shock to the world price of traded goods. With these results, it is possible to assess what information asset prices may give us about the shocks affecting the economy at any particular time.