Abstract:
In this paper we construct a model of stock market, interest rate and output interaction which
is a generalization of the well known 1981 model of Blanchard. We allow for imperfect substitutability
between stocks and bonds in the asset market and for lagged portfolio adjustment. The
reaction of agents to changes in the stock market is dependent on the state of the economy. We
analyze the dynamics of the model and its local stability properties. A discretization in terms of observable
variables is derived. Some empirical results for U.S. output, stock price and interest rate
data are presented using nonlinear least square estimates. We perform some stochastic simulations
of the estimated non-linear model, obtaining distributions of the key economic quantities, their
autocorrelation structure and financial statistics which are compared with historical data and RBC
models. In addition, following Mittnik and Zadrozny (1993) a VAR with confidence bands for
historical data is estimated and cumulative impulse-response functions compared to the model’s
impulse response functions. We find that the model captures a number of features of the data.
