A Model of Monetary Policy and Risk Premia

Itamar Drechsler, Alexi Savov, Philipp Schnabl

NBER Working Paper No. 20141
Issued in May 2014, Revised in August 2015
NBER Program(s):Asset Pricing, Monetary Economics

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 in financial markets, 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.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w20141

Published: ITAMAR DRECHSLER & ALEXI SAVOV & PHILIPP SCHNABL, 2018. "A Model of Monetary Policy and Risk Premia," The Journal of Finance, vol 73(1), pages 317-373.

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