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A Credit-Banking Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles

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Author Info
Scheffel, Eric () (Cardiff Business School)

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Abstract

Micro-founded de-centralized financial intermediation in a cash and costly-credit model (see Gillmand and Kejak, 2008) results in a cost-distortion of returns implying a lower average nominal and real risk-free rate when compared to standard cah-in-advance RBC models. Failure of both short-run and long-run Fisher equation relationships based on observable real and nominal rates and inflation are obtained. The cost-distortion also leads to an unconditionally upward-sloping average yield curve of interest rates which is also convex in shape. The model is capable of producing a positive correlation between the nominal rate and velocity, and a negative correlation between the ex-post real rate and inflation. More importantly, the model also predicts a negative correlation between the ex-ante real rate and the ex-ante expected rate of inflation. Finally, the condition spread between the usual CCAPM rate as defined by Canzoneri and Diba (2005) and the model-implied money market rate is positively correlated with the stance of monetary policy, offering a new perspective on this systematic link recently studied empirically by Canzoneri et al. (2007a) and theoretically by Canzoneri and Diba (2005).

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Paper provided by Cardiff University, Cardiff Business School, Economics Section in its series Cardiff Economics Working Papers with number E2008/30.

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Length: 67 pages
Date of creation: Dec 2008
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Handle: RePEc:cdf:wpaper:2008/30

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Related research
Keywords: Business cycles; Money; Term structure of interest rates;

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Find related papers by JEL classification:
E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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References listed on IDEAS
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Scheffel, Eric, 2008. "Consumption Velocity in a Cash Costly-Credit Model," Cardiff Economics Working Papers E2008/31, Cardiff University, Cardiff Business School, Economics Section. [Downloadable!]
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