Macroeconomic implications of time-varying risk premia

Francois Gourio

No 1463, Working Paper Series from European Central Bank

Abstract: A large empirical literature suggests that risk premia on stocks or corporate bonds are large and countercyclical. This paper studies a simple real business cycle model with a small, exogenously time-varying risk of disaster, and shows that it can replicate several important facts documented in the literature. In the model, an increase in disaster risk leads to a decline of output, investment, stock prices, and interest rates, and an increase in the expected return on risky assets. The model matches well business cycle data and asset price data, and the countercyclicality of risk premia. I present an extension of the model with endogenous choice of leverage and endogenous default, and show that the model accounts well for the level and cyclicality of credit spreads, and in particular the relation between investment and credit spreads. JEL Classification: E32, E44, G12

Keywords: business cycles; credit spreads; investment; rare events; risk premia (search for similar items in EconPapers)
Date: 2012-08
New Economics Papers: this item is included in nep-dge, nep-mac and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20121463

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