NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

A Model of Monetary Policy and Risk Premia

Itamar Drechsler, Alexi Savov, Philipp Schnabl

NBER Working Paper No. 20141
Issued in May 2014
NBER Program(s):   AP   ME

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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Document Object Identifier (DOI): 10.3386/w20141

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