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Evidence that Risk Adjustment is Unnecessary in Estimates of the User Cost of Money

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  • Diego A. Restrepo-Tobón

Abstract

Investors value the special attributes of monetary assets (e.g., exchangeability, liquidity, and safety) and pay a premium for holding them in the form of a lower return rate. The user cost of holding monetary assets can be measured approximately by the difference between the returns on illiquid risky assets and those of safer liquid assets. A more appropriate measure should adjust this difference by the differential risk of the assets in question. We investigate the impact that time non-separable preferences has on the estimation of the risk-adjusted user cost of money. Using U.K. data from 1965Q1 to 2011Q1, we estimate a habit-based asset pricing model with money in the utility function and find that the risk adjustment for risky monetary assets is negligible. Thus, researchers can dispense with risk adjusting the user cost of money in constructing monetary aggregate indexes.

Suggested Citation

  • Diego A. Restrepo-Tobón, 2015. "Evidence that Risk Adjustment is Unnecessary in Estimates of the User Cost of Money," Revista Ecos de Economía, Universidad EAFIT, vol. 19(41), pages 49-70, December.
    • Handle: RePEc:col:000442:014937
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    File URL: http://publicaciones.eafit.edu.co/index.php/ecos-economia/article/view/3346
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    More about this item

    Keywords

    Money; User cost; Habit formation; Asset pricing;
    All these keywords.

    JEL classification:

    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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