Back to the real economy: the effects of risk perception shocks on the term premium and bank lending

Kristina Bluwstein and Julieta Yung

No 806, Bank of England working papers from Bank of England

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 (search for similar items in EconPapers)
JEL-codes: E43 E44 E58 G12 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2019-06-21
New Economics Papers: this item is included in nep-ban, nep-dge, nep-fdg and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0806

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