The equity price channel in a New-Keynesian DSGE model with financial frictions and banking
Stellenbosch Working Paper Series No. WP16/2013 (revised, version: 2)Publication date: 2013
Author(s):
[protected email address] (Department of Economics, University of Stellenbosch)
This paper studies the role of the equity price channel in business cycle fluctuations, and highlights the equity price channel as a different aspect to general equilibrium models with financial frictions and, as a result, emphasizes the systemic influence of financial markets on the real economy. We develop a canonical New-Keynesian DSGE model with a tractable role for the equity market in banking, entrepreneur and household economic activities. The model is estimated with Bayesian techniques using U.S. data over the sample period 1982Q01 - 2012Q01. We show that a New Keynesian DSGE model with an equity price channel well mimics the U.S. business cycle. The model reproduces the strong procyclicality of the equity market. The equity price channel significantly exacerbates business cycle fluctuations through both financial accelerator and bank capital channels. Our results support the increasing emphasis on common equity capital in Basel III regulations. This is beneficial in terms of financial stability, but amplifies and propagates shocks to the real economy.
JEL Classification:E32, E43, E44, E51, G12
Keywords:Equity price channel, asset pricing, financial frictions, bank capital, New-Keynesian, Bayesian
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Monday 28 July 202512:00-13:00
Dr Neil Rankin: Ceo Of Predictive Insights & Stellenbosch University
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Topic: "Two competing approaches in South African competition policy: merger control and anti-cartel enforcement over the past 30 years"
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Topic: "Economic History: TBC"
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25 Jul 2025 Budget hurdle cleared, but US tariff implementation remains a riskIt was another big week on the local political front, but with some constructive momentum. On the trade front, ahead of next week’s 1 August deadline, Trump announced another “massive” trade deal with Japan. The upcoming week is busy, with a slew of global and domestic data releases and several monetary policy decisions, including the SARB....
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