Premium
A Model of Monetary Policy and Risk Premia
Author(s) -
DRECHSLER ITAMAR,
SAVOV ALEXI,
SCHNABL PHILIPP
Publication year - 2018
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12539
Subject(s) - leverage (statistics) , risk premium , market liquidity , liquidity premium , monetary economics , liquidity risk , economics , monetary policy , volatility (finance) , capital asset pricing model , yield curve , interest rate , financial economics , machine learning , computer science
We develop a dynamic 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 (i.e., take deposits) to fund levered investments. Leverage exposes banks to funding risk, which they insure by holding liquidity buffers. By changing the nominal rate the central bank influences the liquidity premium, and hence the cost of taking leverage. Lower nominal rates make liquidity cheaper and raise leverage, resulting in lower risk premia and higher asset prices, volatility, investment, and growth. We analyze forward guidance, a “Greenspan put,” and the yield curve.