Moral Hazard and the US Stockmarket: Analyzing the "Greenspan Put"

Marcus Miller, Paul Weller () and Lei Zhang ()
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Paul Weller: Peterson Institute for International Economics
Lei Zhang: Peterson Institute for International Economics
Authors registered in the RePEc Author Service: Lei Zhang () and Lei Zhang ()

No WP02-1, Working Paper Series from Peterson Institute for International Economics

Abstract: When the risk premium in the US stock market fell far below its historic level, Shiller (2000) attributed this to a bubble driven by psychological factors. As an alternative explanation, we point out that the observed risk premium may be reduced by one-sided intervention policy on the part of the Federal Reserve, which leads investors into the erroneous belief that they are insured against downside risk. By allowing for partial credibility and state dependent risk aversion, we show that this "insurance" - referred to as the Greenspan put - is consistent with the observation that implied volatility rises as the market falls. Our bubble, like Shiller's, involves market psychology, but what we describe is not so much "irrational exuberance" as exaggerated faith in the stabilizing power of Mr. Greenspan.

Date: 2002-01
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Journal Article: Moral Hazard and the US Stock Market: Analysing the "Greenspan Put" (2002)
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