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Back to the real economy: the effects of risk perception shocks on the term premium and bank lending

Kristina Bluwstein and Julieta Yung ()

No 806, Bank of England working papers from Bank of England

Abstract: We develop a dynamic stochastic general equilibrium framework that can account for important macroeconomic and financial moments, given Epstein-Zin preferences, heterogeneous banking and third-order approximation methods that yield a time-varying term premium that feeds back to the real economy. A risk perception shock increases term premia, lowers output, and reduces short-term credit in the private sector in response to higher loan rates and constrained borrowers, as banks rebalance their portfolios. A ‘bad’ credit boom, driven by investors mispricing risk, leads to a more severe recession and is less supportive of economic growth than a ‘good’ credit boom based on fundamentals.

Keywords: Stochastic discount factor; DSGE; long-term interest rate; risk mispricing; macro-financial linkages; bank lending (search for similar items in EconPapers)
JEL-codes: E43 E44 E58 G12 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-dge, nep-fdg and nep-mac
Date: 2019-06-21
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0806

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