Moral Hazard and the US Stock Market: The Idea of a 'Greenspan Put'
AbstractThe risk premium in the US stock market has fallen far below its historic level, which Shiller (2000) attributes to a bubble driven by psychological factors. As an alternative explanation, we point out that the observed risk premium may be reduced by one-sided intervention policy on the part of the Federal Reserve which leads investors into the erroneous belief that they are insured against downside risk. By allowing for partial credibility and state dependent risk aversion, we show that this ‘insurance’ – referred to as the Greenspan put – is consistent with the observation that implied volatility rises as the market falls. Our bubble, like Shiller’s, involves market psychology: but what we describe is not so much ‘irrational exuberance’ as exaggerated faith in the stabilising power of Mr. Greenspan.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3041.
Date of creation: Nov 2001
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Find related papers by JEL classification:
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
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