Open AccessMORAL HAZARD AND THE US STOCK MARKET: ANALYSING THE `GREENSPAN PUT'[Note 1. We would like to thank seminar participants at the ...]
Author(s) -
Miller Marcus,
Weller Paul,
Zhang Lei
Publication year - 2002
Publication title -
the economic journal
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 4.683
H-Index - 160
eISSN - 1468-0297
pISSN - 0013-0133
DOI - 10.1111/1468-0297.00029
Subject(s) - economics , downside risk , stock market , credibility , moral hazard , monetary policy , volatility (finance) , monetary economics , financial economics , stock (firearms) , faith , risk aversion (psychology) , keynesian economics , expected utility hypothesis , microeconomics , philosophy , theology , portfolio , mechanical engineering , paleontology , horse , biology , incentive , engineering , epistemology
When the risk premium in the US stock market fell substantially, Shiller (2000) attributed this to a bubble driven by psychological factors. An alternative explanation is 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 is not so much `irrational exuberance' as exaggerated faith in the stabilising power of Mr. Greenspan.