How Can Consumption-Based Asset-Pricing Models Explain Low Interest Rates?

32 Pages Posted: 21 Aug 2015

See all articles by Felipe F. Schwartzman

Felipe F. Schwartzman

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: August 19, 2015

Abstract

The real interest rate is at historically low levels following the Great Recession. This article examines under which conditions the leading consumption-based asset-pricing models can give rise to such a reduction. In particular, we examine implications of standard constant relative risk aversion preference models with Gaussian shocks, models with consumption disaster, models with long-run risk, and models with habit formation. Given the models reviewed, the high-risk premium suggests that low interest rates in the recent period are likely to be either a consequence of a perception that consumption risk is particularly high, or of very low risk tolerance.

Suggested Citation

Schwartzman, Felipe F., How Can Consumption-Based Asset-Pricing Models Explain Low Interest Rates? (August 19, 2015). FRB Economic Quarterly, vol. 100, no. 3, Third Quarter 2014, pp. 209-240, Available at SSRN: https://ssrn.com/abstract=2647499

Felipe F. Schwartzman (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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