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To match the stylized facts of goods and labor markets, the canonical New Keynesian model augments the optimizing neoclassical growth model with nominal and real rigidities. The authors ask what the implications of this type of model are for asset prices. Using a second-order approximation, they examine bond and equity returns, the equity risk premium, and the behavior of the real and nominal term structure. They catalogue the factors that are most important for determining the size of risk premia and the slope and level of the yield curve.
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