Working Paper: NBER ID: w1141
Authors: Zvi Bodie; Alex Kane; Robert McDonald
Abstract: This paper applies the Capital Asset Pricing Model to help explain the anomalous behavior of real interest rates during the last several years. Specifically,we are able to show that the increased volatility of bond prices since the change in Federal Reserve operating procedure in October 1979 has substantially increased the required real risk premium on long term bonds. We also consider and reject the possibility that increased risk alone accounts for the recent increase in the short-term real rate. Finally, we use the model to simulate the financial effects of a Federal debt maturity management operation.
Keywords: real interest rates; risk premium; CAPM; government debt management
JEL Codes: G12; E43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased volatility of bond prices (G12) | increase in required real risk premium on long-term bonds (E43) |
| increase in required real risk premium on long-term bonds (E43) | influence flat nominal term structure in early 1980s (E43) |
| changes in maturity composition of government debt (H63) | affect equilibrium risk premium on equity (G12) |
| changes in relative supplies of short-term versus long-term government debt (H63) | influence capital formation in the economy (E22) |