Macro-prudential policy and asset pricing

Abstract

I study questions related to the general equilibrium effects of macro-prudential policy designed to restrict speculation driven by belief dispersion among investors. First, I explore the asset pricing implications of differences in beliefs, and I find that belief dispersion caused by overconfidence can explain the downward sloping equity premium term structure and upward sloping bond yield curve. Second, I investigate the impact of speculation driven by belief dispersion on asset prices, social welfare and the aggregate economy. I find speculation reduces social welfare and creates a negative output gap, creating a role for macro-prudential policy. I conclude by studying a general equilibrium asset pricing model with a macro-prudential policy constraint that dampens the leverage cycle. My results show that macroprudential policy can help to mitigate the externalities caused by speculation, enhance economic growth, and increase social welfare even when policy makers do not know the correct physical distribution of exogenous technology shocks.