The Market Price of Risk and Macro-Financial Dynamics

Tobias Adrian, Matthew DeHaven, Fernando Duarte and Tara Iyer

No 2023/199, IMF Working Papers from International Monetary Fund

Abstract: We construct the Volatility Financial Conditions Index (VFCI) as the component of the market price of risk spanned by financial assets. We write a no-arbitrage model with general preferences to show how to estimate the VFCI from the conditional volatility of GDP, even when markets are incomplete. Empirically, the VFCI has greater predictive power than other FCIs for equity, Treasury, and corporate bond risk premia. Across multiple identification strategies, a VFCI shock that tightens financial conditions causes a persistent decline in output and an immediate monetary policy easing. Conversely, contractionary monetary policy shocks cause financial conditions to tighten.

Keywords: Macro-Finance; Financial Conditions Index; Monetary Policy; Asset Pricing; Market Price of Risk; Consumption Volatility; Causal Identification; bond risk premia; contractionary monetary policy shock; tightening of financial conditions; VFCI shock; Structural vector autoregression; Consumption; Asset prices; Estimation techniques; Global; no-arbitrage model; monetary policy easing; market price; Market risk; Vector autoregression; Corporate bonds (search for similar items in EconPapers)
Pages: 87
Date: 2023-09-22
New Economics Papers: this item is included in nep-ban, nep-cba and nep-fdg
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Citations: View citations in EconPapers (1)

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Working Paper: The Market Price of Risk and Macro-Financial Dynamics (2023)
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