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Cheap money and risk taking: Opacity versus fundamental risk

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  • Drees, Burkhard
  • Eckwert, Bernhard
  • Várdy, Felix

Abstract

We explore the effect of interest rates on risk taking and find that it depends on the type of risk involved. In a Bayesian setting, investments can be risky either because payoff-relevant signals are noisy or because the dispersion of the prior is high. While both types of risk contribute symmetrically to the overall riskiness of an investment project, we show that changes in interest rates affect risk taking in these two types of risk in opposite directions. This makes the net effect of interest rates on risk taking—as measured by the average riskiness of financed projects—necessarily ambiguous and dependent on the sources of risk.

Suggested Citation

  • Drees, Burkhard & Eckwert, Bernhard & Várdy, Felix, 2013. "Cheap money and risk taking: Opacity versus fundamental risk," European Economic Review, Elsevier, vol. 62(C), pages 114-129.
    • Handle: RePEc:eee:eecrev:v:62:y:2013:i:c:p:114-129
    DOI: 10.1016/j.euroecorev.2013.05.002
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    Cited by:

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    3. Agur, Itai & Demertzis, Maria, 2019. "Will macroprudential policy counteract monetary policy’s effects on financial stability?," The North American Journal of Economics and Finance, Elsevier, vol. 48(C), pages 65-75.
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    6. Agur, Itai & Demertzis, Maria, 2012. "Excessive bank risk taking and monetary policy," Working Paper Series 1457, European Central Bank.
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    More about this item

    Keywords

    Risk taking; Interest rates; Opacity; Bayesian updating;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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