European Business Schools Librarian's Group

ESSEC Working Papers,
ESSEC Research Center, ESSEC Business School

No DR 08006: Asset Prices and Assymetries in the Fed's Interest Rate Rule : a Financial Approach

Katarzyna Romaniuk () and Radu Vranceanu ()
Additional contact information
Katarzyna Romaniuk: University of Paris 1 Panthéon-Sorbonne, PRISM, Postal: 1, rue Victor Cousin, 75005 PARIS, FRANCE
Radu Vranceanu: ESSEC Business School, Postal: Avenue Bernard Hirsch - B.P. 50105, 95021 CERGY-PONTOISE Cedex , FRANCE,

Abstract: Financial Newspapers have for long suggested that the Fed tends to provide additional Liquidity when the Stock Market thumbs. We provide a theoretical Explanation for this Behaviour that builds on the Methodology developed by Romaniuk (2008) for a central Banker with two main Goals, Output and Price stability. In this Paper, the Policymaker behaves as a Portfolio Manager who aims at stabilizing Output, Goods Prices, as well as Asset Prices. An optimal, Time-varying Interest Rate Rule is obtained as the Merton's (1971) continuous Time Solution to the Portfolio Manager's Problem. In a second Step, we infer the optimal Interest Rate Rule of a central Bank that can react differently to positive and negative Variations in the Stock Market.

Keywords: Optimal Interest Rate Rule; Portfolio Choice; Fed; Asset Prices; Options Theory

JEL-codes: C61; E58; G11

16 pages, March 2008

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