The Tail That Keeps the Riskless Rate Low
Chapter in NBER book NBER Macroeconomics Annual 2018, volume 33 (2019), Martin Eichenbaum and Jonathan A. Parker, editors (p. 253 - 283)
Riskless interest rates fell in the wake of the financial crisis and have remained low. We explore a simple explanation: This recession was perceived as an extremely unlikely event before 2007. Observing such an episode led all agents to re-assess macro risk, in particular, the probability of tail events. Since changes in beliefs endure long after the event itself has passed, perceived tail risk remains high, generates a demand for riskless, liquid assets, and continues to depress the riskless rate. We embed this mechanism in a simple production economy with liquidity constraints and use observable macro data, along with standard econometric tools, to discipline beliefs about the distribution of aggregate shocks. When agents observe an extreme, adverse realization, they re-estimate the distribution and attach a higher probability to such events recurring. As a result, even transitory shocks have persistent effects because, once observed, the shock stays forever in the agents' data set. We show that our belief revision mechanism can help explain the persistent nature of the fall in the risk-free rates.This chapter is no longer available for free download, since the book has been published. To obtain a copy, you must buy the book.
Order from Amazon.com in hardcover or paperback
You may be able to access the full text of this document via the Document Object Identifier.
Document Object Identifier (DOI): https://doi.org/10.1086/700895This chapter first appeared as NBER working paper w24362, The Tail that Keeps the Riskless Rate Low, Julian Kozlowski, Laura Veldkamp, Venky Venkateswaran
Commentary on this chapter:
Comment, François Gourio
Comment, Robert E. Hall