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A Model of Monetary Policy and Risk Premia

Author Info

  • Itamar Drechsler
  • Alexi Savov
  • Philipp Schnabl

Abstract

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
Note: AP ME
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Keywords:

Find related papers by JEL classification:

  • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
  • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
  • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
  • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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Cited by:

  1. Mark Gertler & Peter Karadi, 2014. "Monetary Policy Surprises, Credit Costs and Economic Activity," NBER Working Papers 20224, National Bureau of Economic Research, Inc.
  2. Stefan Nagel, 2014. "The Liquidity Premium of Near-Money Assets," NBER Working Papers 20265, National Bureau of Economic Research, Inc.
  3. Adrian, Tobias & Liang, J. Nellie, 2014. "Monetary policy, financial conditions, and financial stability," Staff Reports 690, Federal Reserve Bank of New York.
  4. Gabriel Chodorow-Reich, 2014. "Effects of Unconventional Monetary Policy on Financial Institutions," NBER Working Papers 20230, National Bureau of Economic Research, Inc.
  5. Alan Moreira & Alexi Savov, 2014. "The Macroeconomics of Shadow Banking," NBER Working Papers 20335, National Bureau of Economic Research, Inc.
  6. Tobias Adrian & Nellie Liang, 2014. "Monetary Policy, Financial Conditions, and Financial Stability," IMES Discussion Paper Series 14-E-13, Institute for Monetary and Economic Studies, Bank of Japan.

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