Moral Hazard And The U.S. Stock Market: Analyzing The 'Greenspan Put'?

21 Pages Posted: 16 Feb 2002  

Marcus H. Miller

University of Warwick - Department of Economics; Institute for International Economics; Centre for Economic Policy Research (CEPR)

Paul A. Weller

University of Iowa - Department of Finance

Lei Zhang

University of Warwick - Department of Economics

Abstract

When the risk premium in the US stock market fell far below its historic level, Shiller (2000) attributed this to a bubble driven by psychological factors. As an alternative explanation, we point out that the observed risk premium may be reduced by one-sided intervention policy on the part of the Federal Reserve, which leads investors into the erroneous belief that they are insured against downside risk. By allowing for partial credibility and state dependent risk aversion, we show that this "insurance" - referred to as the Greenspan put - is consistent with the observation that implied volatility rises as the market falls. Our bubble, like Shiller's, involves market psychology, but what we describe is not so much "irrational exuberance" as exaggerated faith in the stabilizing power of Mr. Greenspan.

Suggested Citation

Miller, Marcus H. and Weller, Paul A. and Zhang, Lei, Moral Hazard And The U.S. Stock Market: Analyzing The 'Greenspan Put'?. Institute for International Economics Working Paper No. 02-01. Available at SSRN: https://ssrn.com/abstract=300896 or http://dx.doi.org/10.2139/ssrn.300896

Marcus H. Miller (Contact Author)

University of Warwick - Department of Economics ( email )

Coventry CV4 7AL
United Kingdom
+44 24 7652 3048/9 (Phone)
+44 24 7652 3032 (Fax)

Institute for International Economics

1750 Massachusetts Avenue, NW
Washington, DC 20036-1903
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Paul A. Weller

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States
319-335-1017 (Phone)
319-335-3690 (Fax)

Lei Zhang

University of Warwick - Department of Economics ( email )

Coventry CV4 7AL
United Kingdom
+44 24 7652 2983 (Phone)
+44 24 7652 3032 (Fax)

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