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MACRO & FINANCE CLUSTER SEMINAR: Term Premium, Credit Risk Premium, and Monetary Policy, joint work with Hiroatsu Tanaka (FRB).

Tuesday 31 January 2017, 2.00PM to 3:00pm

Speaker(s): Andrea Ajello (Fed Board).

We model a Neo-Keynesian economy with Epstein-Zin preferences, financial frictions and multi-period nominal defaultable debt. We calibrate the model to the post-war U.S. economy and solve it using higher-order perturbation methods. We show that credit frictions can significantly increase the size and volatility of the nominal and real Treasury term premium through the interaction of preferences sensitive to long-run risk, and amplification of the economy’s response to TFP shocks. Our analysis suggests that introducing multi-period defaultable debt contracts in DSGE models helps fit the cyclical properties of macroeconomic variables, credit variables such as corporate credit spreads, credit risk premia and leverage ratios together with the main features of the default-free term structure of interest rates. Finally we find that monetary policy that targets inflation fluctuations more than output can reduce the average size of nominal term premia, but does so at the expense of increasing the average risk compensation on defaultable corporate bonds.

Location: HERC (2nd floor above Alcuin Porters Lodge)

Admission: All welcome.