On Reaching for Yield and the Coexistence of Bubbles and Negative Bubbles

52 Pages Posted: 16 Jun 2015 Last revised: 16 Jan 2016

Viral V. Acharya

New York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Hassan Naqvi

SKK Graduate School of Business

Date Written: January 13, 2016

Abstract

We develop a model of financial intermediation characterized by an inside agency problem such that asset managers, when they have access to high enough liquidity, "reach for yield" by overinvesting in risky assets and concurrently underinvesting in safer or medium-risk assets. The managers follow a pecking order whereby their first preference is to invest in risky assets; their second preference is to hoard liquid assets so as to provide a buffer against runs; and their last preference is to invest in medium-risk assets. This reaching-for-yield behavior of managers is conducive to the formation of bubbles in the market for risky assets and concurrently "negative bubbles" in the market for medium-risk assets. We show that loose monetary policy by reducing the cost of liquidity shortfalls suffered by financial intermediaries induces further "reach for yield" and amplifies the magnitude of bubbles and negative bubbles.

The appendices for this paper are available at the following URL: http://ssrn.com/abstract=2619004.

Keywords: Bubbles, monetary policy, moral hazard, negative bubbles, reaching for yield

JEL Classification: D82, E32, E52, G21, G28

Suggested Citation

Acharya, Viral V. and Naqvi, Hassan, On Reaching for Yield and the Coexistence of Bubbles and Negative Bubbles (January 13, 2016). Available at SSRN: https://ssrn.com/abstract=2618973 or http://dx.doi.org/10.2139/ssrn.2618973

Viral V. Acharya

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
New York, NY NY 10012
United States

HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance

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

Hassan Naqvi (Contact Author)

SKK Graduate School of Business ( email )

206 International Hall
Seoul, 110-745
Korea, Republic of (South Korea)

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