The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
Observers have often characterized asset markets as being subject to periods of tranquility and periods of turbulence. Until recently, however, researchers were unable to produce closed-form asset pricing formulas in a model environment of time-varying risk. Some work by Abel provided us with the insights needed to produce such formulas. This paper gives a exposition of how to develop the formulas in an environment where the formulas may by obtained using a simple extension of standard tools. While the paper is intended mainly as an exposition of new work, it also contains a report on the asset market effect of fiscal reform. It is found that entering a period of weak coordination between government spending and taxing (tax rate) policy is good for stock prices.