Back to the Real Economy: The Effects of Risk Perception Shocks on the Term Premium and Bank Lending
42 Pages Posted: 19 Jul 2019
Date Written: June 21, 2019
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
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