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A Model of Monetary Policy and Risk Premia

  • Itamar Drechsler
  • Alexi Savov
  • Philipp Schnabl

We present a dynamic heterogeneous-agent asset pricing model in which monetary policy affects the risk premium component of the cost of capital. Risk tolerant agents (banks) borrow from risk averse agents (depositors) and invest in risky assets subject to a reserve requirement. By varying the nominal interest rate, the central bank affects the spread banks pay for external funding (i.e., leverage), a link that we show has strong empirical support. Lower nominal rates result in increased leverage, lower risk premia and overall cost of capital, and higher volatility. The effects of policy shocks are amplified via bank balance sheet effects. We use the model to implement dynamic interventions such as a ``Greenspan put'' and forward guidance, and analyze their impact on asset prices and volatility.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 20141.

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Date of creation: May 2014
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Handle: RePEc:nbr:nberwo:20141
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