A Model of Monetary Policy and Risk Premia

63 Pages Posted: 7 Nov 2013 Last revised: 5 Jan 2017

See all articles by Itamar Drechsler

Itamar Drechsler

Wharton School, Department of Finance; National Bureau of Economic Research (NBER)

Alexi Savov

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Philipp Schnabl

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: July 28, 2015

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, leverage, risk premia, reaching for yield

JEL Classification: E52, E58, G12, G21

Suggested Citation

Drechsler, Itamar and Savov, Alexi and Schnabl, Philipp, A Model of Monetary Policy and Risk Premia (July 28, 2015). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2350556 or http://dx.doi.org/10.2139/ssrn.2350556

Itamar Drechsler

Wharton School, Department of Finance ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

HOME PAGE: http://https://sites.google.com/site/idrechsl/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Alexi Savov (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Philipp Schnabl

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/pschnabl/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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