Think of this question in the context of the two-period model. Households hold stocks as part...

Think of this question in the context of the two-period model.

Households hold stocks as part of their financial wealth. Assume that we recently observe stock prices rising. Also assume that consumers believe that changes in stock prices are temporary. What affect would this have on the correlation between stock price indices and consumption? Explain.

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Answer

The two time period model basically consist of two time period.The first time period is the current time or today and the second time period is the tomorrow or future time period .The temporary income affect only the first time period that is current but the permanment income affect both the current time and future time periods In the problem of household stocks , the stock price is increasing and this can be due to different factors like economic change within the country ,changes withing the household industries ,political events,and can be environmental changes.and with the assumption that increase in the stock price is temporary , it will have the impact on the first period in the two time period model consideration.Now , the effect of this on the correlation between the e temporary. What affect would this have on the correlation between stock price indices and consumption will be like ,inhcrease in the stock price will reduce the consumption and vice versa which is for first period only and in the second period in the two time period model , this will have neutral affect as we took the assumption of temporary affect of changes in stock prices .

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Rahul Sunny answered 7 months ago

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