THE JOURNAL OF FINANCE
VOL. LXXIII, NO. 1
A Model of Monetary Policy and Risk Premia
ITAMAR DRECHSLER, ALEXI SAVOV, and PHILIPP SCHNABL
We develop a dynamic asset pricing model in which monetary policy affects the risk
premium component of the cost of capital. Risk-tolerant agents (banks) borrow from
risk-averse agents (i.e., take deposits) to fund levered investments. Leverage exposes
banks to funding risk, which they insure by holding liquidity buffers. By changing the
nominal rate the central bank inﬂuences the liquidity premium, and hence the cost
of taking leverage. Lower nominal rates make liquidity cheaper and raise leverage,
resulting in lower risk premia and higher asset prices, volatility, investment, and
growth. We analyze forward guidance, a “Greenspan put,” and the yield curve.
N TEXTBOOK MODELS
(2003)), monetary policy works by chang-
ing the real interest rate. Yet a growing body of empirical evidence shows that
monetary policy also has a large impact on the risk premium component of
the cost of capital.
Moreover, many central bank interventions can be use-
fully interpreted as targeting risk premia. For instance, a “Greenspan put” in
the 1990s and low interest rates in the mid-2000s arguably led to excessive
leverage and compressed spreads.
During the ﬁnancial crisis, large-scale as-
set purchases, equity injections, and asset guarantees were all explicitly aimed
at supporting risky asset prices (see Bernanke (2013) for a discussion). Since
the crisis, with spreads near historic lows, an important debate has centered on
whether low interest rates fuel “reaching for yield” and as a result pose a threat
to ﬁnancial stability (Stein (2014)). These observations point to an underlying
risk premium channel of monetary policy.
The authors are from New York University Stern School of Business and NBER. Schnabl is
also with CEPR. We thank Ken Singleton (the Editor), two anonymous referees, Viral Acharya,
Xavier Gabaix, John Geanakoplos, Valentin Haddad, Matteo Maggiori, Alan Moreira, Stefan Nagel,
Francisco Palomino, and Cecilia Parlatore, as well as participants at the 2012 CITE conference,
the 2013 Kellogg Junior Macro conference, the Princeton Finance Seminar, the 2013 Five-Star
Conference at NYU, the 2014 UBC Winter Finance Conference, the 2014 Cowles GE Conference
at Yale, Harvard Business School, the 2014 Woolley Centre conference at LSE, the Minneapolis
Fed, the 2015 AFA Meetings, the 2015 FARFE Conference, the New York Federal Reserve, and the
Federal Reserve Board. The authors have read the Disclosure Policy of the Journal of Finance and
have nothing to disclose.
Bernanke and Kuttner (2005) show that monetary policy surprises have a large impact on
stock prices and that this impact primarily reﬂects changes in risk premia. Hanson and Stein
(2015) and Gertler and Karadi (2015) ﬁnd parallel results for long-term bond yields and credit
spreads. Gilchrist and Zakraj
sek (2012) ﬁnd that changes in risk premia have a strong inﬂuence
on the macroeconomy.
See, for example, Blinder and Reis (2005), Rajan (2011), and Yellen (2011).