Monetary Policy Rules and Asset Prices in a Segmented Markets Model

We study the effect of different monetary policy rules on stock and bond risk usinga segmented financial market model. The optimal monetary policy rule in our modelis risk-sharing and countercyclical after shocks in the financial markets. Under thatpolicy, equity is not risky, and its return is low. The optimal policy, however, impliesinflation risk and thus high return for nominal bonds. On the other hand, underinflation targeting there is no insurance against financial income risk and the equityreturn is high. At the same time, inflation targeting insures against inflation, resultingin nominal bonds becoming attractive assets. Our model suggests that monetary policyobjectives play a key role in affecting risk sharing and asset returns