News Shocks and Asset Prices

Abstract We examine the role of expectation, or news, shocks for the identification of macroeconomic risk and the natural rate of interest. To this end, we estimate a New-Keynesian dynamic stochastic general equilibrium model that allows us to infer agents' expectations about future fundamentals at different horizons. Accounting for news shocks results in better-specified macroeconomic risk factors that have significant explanatory power for the cross section of stock and long-term bond returns. Further, anticipated changes in future productivity growth induce sizable fluctuations in the natural rate of interest, which we show to have important implications for the conduct of monetary policy