Working Paper: NBER ID: w20141
Authors: Itamar Drechsler; Alexi Savov; Philipp Schnabl
Abstract: 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.
Keywords: Monetary Policy; Risk Premium; Cost of Capital; Leverage; Liquidity Premium
JEL Codes: E52; E58; G12; G21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Changes in the nominal interest rate (E43) | Liquidity premium (G19) |
| Liquidity premium (G19) | Cost of taking leverage (G19) |
| Changes in the nominal interest rate (E43) | Cost of taking leverage (G19) |
| Cost of taking leverage (G19) | Risk-taking behavior (D91) |
| Risk-taking behavior (D91) | Risk premia (G19) |
| Changes in the nominal interest rate (E43) | Risk-taking behavior (D91) |
| Risk aversion (D81) | Risk premia (G19) |
| Risk premia (G19) | Asset prices (G19) |
| Nominal interest rate (E43) | Macroeconomic outcomes (E19) |