A Model of Endogenous Risk Intolerance and LSAPs: Asset Prices and Aggregate Demand in a “COVID-19” Shock

Financial intermediaries and the cross-section of asset returns

Ricardo Caballero () and Alp Simsek

The Review of Financial Studies, 2021, vol. 34, issue 11, 5522-5580

Abstract: We theoretically investigate the interaction of endogenous risk intolerance and monetary policy following a large recessionary shock. As asset prices dip, risk-tolerant agents’ wealth share declines. This decline reduces the market’s risk tolerance and triggers a downward loop in asset prices and aggregate demand when the interest rate policy is constrained. In this context, large-scale asset purchases are effective because they transfer unwanted risk to the government’s balance sheet. These effects are sizable when the model is calibrated to match the estimates of aggregate asset demand inelasticity. The COVID-19 shock illustrates the environment we seek to capture.

JEL-codes: E30 E40 E50 G01 G10 G20 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (23)

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Working Paper: A Model of Endogenous Risk Intolerance and LSAPs: Asset Prices and Aggregate Demand in a "Covid-19" Shock (2020)
Working Paper: A Model of Endogenous Risk Intolerance and LSAPs: Asset Prices and Aggregate Demand in a “Covid-19” Shock (2020)
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