Abstract:

This work studies the impact of central bank activity on the optimal portfolio choice of a long-term investor. The setting proposed incorporates a Taylor rule into an extended term structure model, accounting for macroeconomic risks and equity dynamics. Empirical evidence shows that an actively conservative monetary policy (higher weight on price stability relative to real economic activity) provides a better hedge of inflation, increases nominal bond volatility and leads to a reduction of the positions in risky assets, as well as to an overall increase of welfare. Furthermore, when the investor derives utility over real balances, a hedging demand covering instantaneous variations in relative risk aversion appears in the optimal strategy, causing bond positions to be reduced.