Working Paper: CEPR ID: DP14207
Authors: David Sraer; Valentin Haddad
Abstract: Banks' balance-sheet exposure to fluctuations in interest rates strongly forecasts excess Treasury bond returns. This result is consistent with optimal risk management, a banking counterpart to the household Euler equation. In equilibrium, the bond risk premium compensates banks for bearing fluctuations in interest rates. When banks' exposure to interest rate risk increases, the price of this risk simultaneously rises. We present a collection of empirical observations supporting this view, but also discuss several challenges to this interpretation.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| banks' balance sheet exposure to interest rate fluctuations (G21) | excess treasury bond returns (G12) |
| average income gap (D31) | excess treasury bond returns (G12) |
| average income gap (D31) | bond risk premia (G12) |