Equity Pricing in New Keynesian Models with Nominal Rigidities and Investment

This paper derives explicitly an equity pricing relationship in a New Keynesian model. This relationship is used to study the equity pricing implications of New Keynesian models. I find that New Keynesian models suffer from the same asset pricing shortcomings as more traditional RBC versions. This is attributed to the presence of a new `forward looking' channel induced by the presence of nominal rigidities. However, once capital adjustment costs are introduced I find that the presence of nominal rigidities leads to a significant quantitative improvement in the equity return and equity premium. Thus this paper shows that what matters for equity pricing, and asset pricing more broadly, in models with nominal rigidities are the general equilibrium interactions with other rigidities via the forward looking channel