A Macroeconomic Model of Equities and Real, Nominal, and Defaultable Debt

Linkages between the real economy and financial markets can be very important, as evidenced by the 2007-09 financial crisis and European sovereign debt crisis. This paper develops a simple, structural macroeconomic model that is consistent with a wide variety of asset pricing facts, such as the size and variability of risk premia on equities, real and nominal government bonds, and corporate bonds, commonly referred to as the equity premium puzzle, bond premium puzzle, and credit spread puzzle, respectively. The paper makes two main contributions: First, it unifies a variety of asset pricing puzzles in a simple, structural asset pricing framework. Second, it shows how standard dynamic macroeconomic models can be brought into agreement with a range of asset prices, making it possible to use these models to study the linkages between risk premia in financial markets and the real economy.