Our survey contributes to the literature on the links between asset prices and macroeconomic outcomes in several dimensions. First, it presents a broad review of the theoretical and empirical work on the main determinants of asset prices and the basic linkages between asset prices and economic activity. Second, it documents that basic models are able to capture many linkages as documented by a wide range of empirical studies. However, it also shows that a number of puzzles remain regarding the behaviour of asset prices and their interactions with macroeconomic outcomes. Third, it emphasises the global dimensions of asset price determination, the linkages between asset prices and economic activity and the critical role of such prices in the transmission of shocks across borders. Finally, to help guide future research, the survey attempts to identify the major gaps in knowledge on these issues.

Given the complex nature of the linkages between asset prices and macroeconomic outcomes, a survey on the topic comes with a number of caveats. First, both asset prices and macroeconomic outcomes are endogenous variables and, as a result, the nature of the relationships between them ultimately depends on the models employed for the analysis. Our objective here is to present the basic linkages in the context of standard models and review the most relevant empirical studies that test for the presence of these links. Second, while we study the linkages between asset prices and macroeconomic outcomes, we are keenly aware that many micro-level factors drive macro-level variables. Hence, whenever possible, we draw lessons from theoretical and empirical studies at the microeconomic level for macroeconomic aggregates.

Third, our focus is mostly on standard models, ie models that do not necessarily account for financial market imperfections. We consider these “frictionless” models as the benchmark frameworks to study the linkages between asset prices and macroeconomic outcomes. We present a discussion of models with financial imperfections in our companion survey (Claessens and Kose (2017)). Finally, although we did our best to include all major studies on the topic, it is unavoidable that a survey on such a vast literature would miss some contributions.

We start with a general discussion of the determinants of asset prices with standard models of “complete markets”. These models often apply to all types of asset. But to simplify the presentation, we first focus on equity and house prices within a closed economy context. We then analyse the international dimensions of asset prices. Next, we discuss in more detail two other major asset prices: exchange rates and interest rates (and related bond prices). In order to make our survey more accessible, each section provides a self-contained review of the relevant segments of the literature. We also structure each section to address systematically the three questions posed above.

Section 2 starts with a brief analysis of the determination of asset prices in standard models. Models operating within a “complete markets” paradigm provide the basic analytical foundations for the determination of asset prices. Asset prices, like other prices, are endogenous and adjust to clear markets, including “anonymous” financial markets in these models. The standard models provide useful frameworks as they highlight the basic linkages between asset prices and agents’ decisions, including through the well-known channels associated with wealth and substitution effects. Asset prices also provide economic agents with signals that allow them to make optimal saving and investment decisions. They also carry information about future profitability and income growth.

and Robert Shiller). Woodford (2003) analyses interest rates and prices and the role of monetary policy in shaping them. Sarno and Taylor (2002), Klein and Shambough (2010), Chinn (2012), Rossi (2013) and Engel (2014) provide extensive surveys of different aspects of exchange rates.

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