A Credit-Banking Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles

Eric Scheffel

No E2008/30, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

Abstract: Micro-founded de-centralized financial intermediation in a cash and costly-credit model (see Gillmand and Kejak, 2008) results in a cost-distortion of returns implying a lower average nominal and real risk-free rate when compared to standard cah-in-advance RBC models. Failure of both short-run and long-run Fisher equation relationships based on observable real and nominal rates and inflation are obtained. The cost-distortion also leads to an unconditionally upward-sloping average yield curve of interest rates which is also convex in shape. The model is capable of producing a positive correlation between the nominal rate and velocity, and a negative correlation between the ex-post real rate and inflation. More importantly, the model also predicts a negative correlation between the ex-ante real rate and the ex-ante expected rate of inflation. Finally, the condition spread between the usual CCAPM rate as defined by Canzoneri and Diba (2005) and the model-implied money market rate is positively correlated with the stance of monetary policy, offering a new perspective on this systematic link recently studied empirically by Canzoneri et al. (2007a) and theoretically by Canzoneri and Diba (2005).

Keywords: Business cycles; Money; Term structure of interest rates (search for similar items in EconPapers)
JEL-codes: E4 E44 (search for similar items in EconPapers)
Pages: 67 pages
Date: 2008-12
New Economics Papers: this item is included in nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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