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Working Paper
Credit-crunch dynamics with uninsured investment risk
I study the effects of credit tightening in an economy with uninsured idiosyncratic investment risk. In the model, entrepreneurs require an equity premium because collateral constraints limit insurance. After collateral constraints tighten, the equity premium and the riskiness of consumption rise and the risk-free interest rate falls. I show that, both immediately after the shock and in the long run, the equity premium and the riskiness of consumption increase more than they would if the risk-free rate were constant. Indeed, the long-run increase in the riskiness of consumption growth is ...
Working Paper
Credit-crunch dynamics with uninsured investment risk
I study the effects of credit tightening in an economy with uninsured idiosyncratic investment risk. In the model, entrepreneurs require an equity premium because collateral constraints limit insurance. After collateral constraints tighten, the equity premium and the riskiness of consumption rise and the risk-free interest rate falls. I show that, both immediately after the shock and in the long run, the equity premium and the riskiness of consumption increase more than they would if the risk-free rate were constant. Indeed, the long-run increase in the riskiness of consumption growth is ...
Discussion Paper
Dealer Balance Sheet Capacity and Market Liquidity during the 2013 Selloff in Fixed-Income Markets
Long-term interest rates hit record-low levels in 2012 but have since increased substantially. As discussed in an earlier post, the sharpest increase occurred between May 2 and July 5 of this year, with the ten-year Treasury yield rising from 1.63 percent to 2.74 percent. During the May-July episode, market liquidity also deteriorated. Some market participants have suggested that constraints on dealer balance sheet capacity impaired liquidity during the selloff, amplifying the magnitude and speed of the rise in interest rates and volatility. In this post, we review the evolution of Treasury ...
Working Paper
Idiosyncratic Investment Risk and Business Cycles
I show that, due to imperfect risk sharing, aggregate shocks to uncertainty about idiosyncratic return on investment generate economic contractions with elevated risk premia and a decrease in the risk-free rate. I present a tractable real business cycle model in which firms experience idiosyncratic shocks, to which managers are at least partially exposed; the distribution of these shocks is time-varying and stochastic. I show that the path for aggregate quantities, the price of physical capital, and the equity premium are the same as in a model without idiosyncratic risk, but with ...
Discussion Paper
Dealer Inventory Constraints during the COVID-19 Pandemic: Evidence from the Treasury Market and Broader Implications
Strains in the Treasury market in March indicated a decline in broker-dealer inventory capacity, which has historically predicted persistent reductions in market liquidity across asset classes, the availability of financing for non-financial firms, and real activity.
Working Paper
Monetary Policy Strategies and Tools: Financial Stability Considerations
This paper examines potential interactions between financial stability and the monetary policy strategies and tools considered in the Federal Reserve’s review of monetary policy strategy, tools, and communication practices. Achieving the Federal Reserve’s goals of full employment and price stability promotes financial stability. A key concern, however, is that with a low equilibrium real interest rate, a low policy rate will be necessary, and in turn, these low rates may contribute to an increase in financial system vulnerabilities. Our analysis suggests that there are typically ...
Discussion Paper
Dealer Balance Sheet Capacity and Market Liquidity during the 2013 Selloff in Fixed Income Markets
Long-term interest rates hit record-low levels in 2012 but have since increased substantially.
Discussion Paper
Dealer Inventory Constraints in the Corporate Bond Market during the COVID Crisis
Beginning in late February 2020, market liquidity for corporate bonds dried up and corporate bond credit spreads soared amid broad financial market dislocations related to the COVID-19 pandemic. The causes of this liquidity dry-up and the spike in corporate bond spreads remain subjects of debate.