Stock market, interest rate and output: a model and estimation for US time series data

In this paper we construct a model of stock market, interest rate and output interaction whichis a generalization of the well known 1981 model of Blanchard. We allow for imperfect substitutabilitybetween stocks and bonds in the asset market and for lagged portfolio adjustment. Thereaction of agents to changes in the stock market is dependent on the state of the economy. Weanalyze the dynamics of the model and its local stability properties. A discretization in terms of observablevariables is derived. Some empirical results for U.S. output, stock price and interest ratedata are presented using nonlinear least square estimates. We perform some stochastic simulationsof the estimated non-linear model, obtaining distributions of the key economic quantities, theirautocorrelation structure and financial statistics which are compared with historical data and RBCmodels. In addition, following Mittnik and Zadrozny (1993) a VAR with confidence bands forhistorical data is estimated and cumulative impulse-response functions compared to the model?simpulse response functions. We find that the model captures a number of features of the data.