Hostname: page-component-586b7cd67f-t7czq Total loading time: 0 Render date: 2024-11-26T06:10:27.677Z Has data issue: false hasContentIssue false
  • English
  • Français

LONG-RUN RISK AND MONEY MARKET RATES: AN EMPIRICAL ASSESSMENT

Published online by Cambridge University Press:  07 June 2016

Stefano d'Addona
Stefano d'Addona*
Affiliation:
University of Rome Tre
*
Address correspondence to: Stefano d'Addona, Department of Political Science, University of Rome Tre, Via G. Chiabrera, 199, I-00145 Rome, Italy; e-mail: [email protected].
Get access Rights & Permissions [Opens in a new window]

Abstract

Using postwar U.S. data, I study the implied interest rates in a simple long-run risk (LRR) model. Empirical estimates show that, as in standard consumption-based models with power utility preferences, the movements of the implied risk-free rate are entirely determined by the variations of expected consumption growth. This leads to a negative relationship between LRR Euler equation rates and money market rates. Nevertheless, when the low-frequency movements of consumption growth are accounted for, the long-run component of consumption growth is a key element to partially capture the countercyclical variations of the money market rates.

Keywords

Long-Run RiskEuler Interest RatesMonetary Policy
Type
Articles
Information
Macroeconomic Dynamics , Volume 21 , Issue 4 , June 2017 , pp. 1096 - 1117
Copyright
Copyright © Cambridge University Press 2016 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

I thank seminar participants at the University of California, Riverside, and at the 2014 Conference of the International Association for Applied Econometrics for helpful discussions. I am grateful to William A. Barnett (the Editor) and two anonymous referees for their comments and suggestions. An earlier version of this paper was circulated under the title “Money market implications of long run risk models”; I thank Ilaria Musumeci for her support in drafting the previous version of this work.

References

REFERENCES

Abel, A. B. (1990) Asset pricing under habit formation and catching up with the Joneses. American Economic Association Papers and Proceedings 80, 38–42.Google Scholar
Ahmad, Y. (2005) Money market rates and implied CCAPM rates: Some international evidence. Quarterly Review of Economics and Finance 45, 699–729.Google Scholar
Atkeson, A. and Kehoe, P.J. (2009) On the need for a new approach to analyzing monetary policy. NBER Macroeconomics Annual 23, 389–425.Google Scholar
Bandi, F.M. and Perron, B. (2008) Long-run risk-return trade-offs. Journal of Econometrics 143, 349–374.Google Scholar
Bansal, R., Kiku, D., and Yaron, A. (2007) Risks for the Long Run: Estimation and Inference. Working paper, University of Pennsylvania.Google Scholar
Bansal, R. and Shaliastovich, I. (2013) A long-run risks explanation of predictability puzzles in bond and currency markets. Review of Financial Studies 26, 1–33.Google Scholar
Bansal, R. and Yaron, A. (2004) Risks for the long run: A potential resolution of asset pricing puzzles. Journal of Finance 59, 1481–1509.CrossRefGoogle Scholar
Beeler, J. and Campbell, J. (2012) The long-run risks model and aggregate asset prices: An empirical assessment. Critical Finance Review 1, 141–182.Google Scholar
Brevik, F. and d'Addona, S. (2011) Information quality and stock returns revisited. Journal of Financial and Quantitative Analysis 45, 1419–1446.Google Scholar
Campbell, J.Y. and Cochrane, J.H. (1999) By force of habit: A consumption-based explanation of aggregate stock market behavior. Journal of Political Economy 107, 205–251.CrossRefGoogle Scholar
Campbell, J.Y. and Shiller, R.J. (1988) The dividend–price ratio and expectations of future dividends and discount factors. Review of Financial Studies 1, 195–228.Google Scholar
Canzoneri, M.B., Cumby, R.E., and Diba, B.T. (2007) Euler equations and money market rates: A challenge for monetary policy models. Journal of Monetary Economics 54, 1863–1881.CrossRefGoogle Scholar
Christiano, L.J., Eichenbaum, M., and Evans, C.L. (1999) Monetary policy shocks: What have we learned and to what end? In Taylor, John B. and Woodford, Michael (eds.), Handbook of Macroeconomics, Vol. 1, Part A, pp. 65–148. Elsevier.CrossRefGoogle Scholar
Dew-Becker, I. and Giglio, S. (2013) Asset Pricing in the Frequency Domain: Theory and Empirics. Working paper 19416, National Bureau of Economic Research.Google Scholar
Epstein, L.G. and Zin, S. (1989) Substitution, risk aversion, and the temporal behavior of consumption growth and asset returns: I. A theoretical framework. Econometrica 57, 937–969.Google Scholar
Gavazzoni, F. (2012) Nominal Frictions, Monetary Policy, and Long-Run Risk. Working paper 97, INSEAD.Google Scholar
Gelfand, A.E., Smith, A.F.M., and Lee, T.-M. (1992) Bayesian analysis of constrained parameter and truncated data problems using Gibbs sampling. Journal of the American Statistical Association 87, 523–532.Google Scholar
Hansen, L.P. (2007) Beliefs, doubts and learning: Valuing macroeconomic risk. American Economic Review 97, 1–30.Google Scholar
Hansen, L.P., Heaton, J., and Li, N. (2008) Consumption strikes back? Measuring long-run risk. Journal of Political Economy 116, 260–302.Google Scholar
Koijen, R.S.J., Lustig, H., Van Nieuwerburgh, S., and Verdelhan, A. (2010) Long run risk, the wealth–consumption ratio, and the temporal pricing of risk. American Economic Review 100, 552–556.Google Scholar
Li, E.X. and Palomino, F. (2014) Nominal rigidities, asset returns, and monetary policy. Journal of Monetary Economics 66, 210–225.Google Scholar
Mehra, R. and Prescott, E.C. (1985) The equity premium: A puzzle. Journal of Monetary Economics 15, 145–161.Google Scholar
Ortu, F., Tamoni, A., and Tebaldi, C. (2013) Long-run risk and the persistence of consumption shocks. Review of Financial Studies 26, 2876–2915.Google Scholar
Prais, G.J. and Winsten, C. (1954) Trend Estimators and Serial Correlation. Discussion papers 383, Cowles Commission.Google Scholar
Reynard, S. and Schabert, A. (2010) Modeling Monetary Policy. Working paper 2010-04, Swiss National Bank.CrossRefGoogle Scholar
Rudebusch, G.D. and Swanson, E.T. (2012) The bond premium in a DSGE model with long-run real and nominal risks. American Economic Journal: Macroeconomics 4, 105–143.Google Scholar
Schorfheide, F., Song, D., and Yaron, A. (2014) Identifying Long-Run Risks: A Bayesian Mixed-Frequency Approach. Working paper 20303, National Bureau of Economic Research.Google Scholar
Tallarini, T.D. (2000) Risk-sensitive real business cycles. Journal of Monetary Economics 45, 507–532.Google Scholar
Weil, P. (1989) The equity premium puzzle and the risk free rate puzzle. Journal of Monetary Economics 24, 401–421.Google Scholar