Back to the Real Economy: The Effects of Risk Perception Shocks on the Term Premium and Bank Lending

42 Pages Posted: 19 Jul 2019

See all articles by Kristina Bluwstein

Kristina Bluwstein

Bank of England

Julieta Yung

Federal Deposit Insurance Corporation

Date Written: June 21, 2019

Abstract

We develop a dynamic stochastic general equilibrium framework that can account for important macroeconomic and financial moments, given Epstein-Zin preferences, heterogeneous banking and third-order approximation methods that yield a time-varying term premium that feeds back to the real economy. A risk perception shock increases term premia, lowers output, and reduces short-term credit in the private sector in response to higher loan rates and constrained borrowers, as banks rebalance their portfolios. A ‘bad’ credit boom, driven by investors mispricing risk, leads to a more severe recession and is less supportive of economic growth than a ‘good’ credit boom based on fundamentals.

Keywords: stochastic discount factor, DSGE, long-term interest rate, risk mispricing, macro-financial linkages, bank lending

JEL Classification: E43, E44, E58, G12

Suggested Citation

Bluwstein, Kristina and Yung, Julieta, Back to the Real Economy: The Effects of Risk Perception Shocks on the Term Premium and Bank Lending (June 21, 2019). Bank of England Working Paper No. 806, June 2019, Available at SSRN: https://ssrn.com/abstract=3422829 or http://dx.doi.org/10.2139/ssrn.3422829

Kristina Bluwstein (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Julieta Yung

Federal Deposit Insurance Corporation ( email )

550 17th Street NW
Washington, DC 20006

HOME PAGE: http://https://www.fdic.gov/analysis/cfr/

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