The Market Price of Risk and Macro-Financial Dynamics
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Summary:
We propose the conditional volatility of GDP spanned by financial factors as a “Volatility Financial Conditions Index” (VFCI) and show it is closely tied to the market price of risk. The VFCI exhibits superior explanatory power for stock and bond risk premia compared to other FCIs. We use a variety of identification strategies and instruments to demonstrate robust causal relationships between the VFCI and macroeconomic aggregates: a tightening of financial conditions as measured by the VFCI leads to a persistent contraction of output and triggers an immediate easing of monetary policy. Conversely, contractionary monetary policy shocks cause tighter financial conditions.
Series:
Working Paper No. 2023/199
Subject:
Asset prices Consumption Econometric analysis Estimation techniques Financial conditions index Financial sector policy and analysis National accounts Prices Structural vector autoregression
Frequency:
regular
English
Publication Date:
September 22, 2023
ISBN/ISSN:
9798400255397/1018-5941
Stock No:
WPIEA2023199
Format:
Paper
Pages:
87
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