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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. Boucekkine, Raouf & Kazuo, Nishimura & Venditti, Alain, 2017. "Introduction to international financial markets and banking systems crises," Journal of Mathematical Economics, Elsevier, vol. 68(C), pages 87-91.
    4. Agur, Itai & Demertzis, Maria, 2013. "“Leaning against the wind” and the timing of monetary policy," Journal of International Money and Finance, Elsevier, vol. 35(C), pages 179-194.
    5. Agur, Itai & Demertzis, Maria, 2012. "Excessive bank risk taking and monetary policy," Working Paper Series 1457, European Central Bank.
    6. Cociuba, Simona E. & Shukayev, Malik & Ueberfeldt, Alexander, 2016. "Collateralized borrowing and risk taking at low interest rates," European Economic Review, Elsevier, vol. 85(C), pages 62-83.
    7. Colletaz, Gilbert & Levieuge, Grégory & Popescu, Alexandra, 2018. "Monetary policy and long-run systemic risk-taking," Journal of Economic Dynamics and Control, Elsevier, vol. 86(C), pages 165-184.
    8. 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.
    9. Agur, Itai, 2019. "Monetary and macroprudential policy coordination among multiple equilibria," Journal of International Money and Finance, Elsevier, vol. 96(C), pages 192-209.

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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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