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Cheap money and risk taking: Opacity versus fundamental risk

Burkhard Drees (), Bernhard Eckwert and Felix Vardy ()

European Economic Review, 2013, vol. 62, issue C, 114-129

Abstract: We explore the effect of interest rates on risk taking and find that it depends on the type of risk involved. In a Bayesian setting, investments can be risky either because payoff-relevant signals are noisy or because the dispersion of the prior is high. While both types of risk contribute symmetrically to the overall riskiness of an investment project, we show that changes in interest rates affect risk taking in these two types of risk in opposite directions. This makes the net effect of interest rates on risk taking—as measured by the average riskiness of financed projects—necessarily ambiguous and dependent on the sources of risk.

Keywords: Risk taking; Interest rates; Opacity; Bayesian updating (search for similar items in EconPapers)
JEL-codes: D80 G11 (search for similar items in EconPapers)
Date: 2013
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DOI: 10.1016/j.euroecorev.2013.05.002

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European Economic Review is currently edited by T.S. Eicher, A. Imrohoroglu, E. Leeper, J. Oechssler and M. Pesendorfer

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