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LONG-RUN RISK AND MONEY MARKET RATES: AN EMPIRICAL ASSESSMENT

Published online by Cambridge University Press:  07 June 2016

Stefano d'Addona
Stefano d'Addona*
Affiliation:
University of Rome Tre
*
Address correspondence to: Stefano d'Addona, Department of Political Science, University of Rome Tre, Via G. Chiabrera, 199, I-00145 Rome, Italy; e-mail: daddona@uniroma3.it.
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Abstract

Using postwar U.S. data, I study the implied interest rates in a simple long-run risk (LRR) model. Empirical estimates show that, as in standard consumption-based models with power utility preferences, the movements of the implied risk-free rate are entirely determined by the variations of expected consumption growth. This leads to a negative relationship between LRR Euler equation rates and money market rates. Nevertheless, when the low-frequency movements of consumption growth are accounted for, the long-run component of consumption growth is a key element to partially capture the countercyclical variations of the money market rates.

Keywords

Long-Run RiskEuler Interest RatesMonetary Policy
Type
Articles
Information
Macroeconomic Dynamics , Volume 21 , Issue 4 , June 2017 , pp. 1096 - 1117
Copyright
Copyright © Cambridge University Press 2016 

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Footnotes

I thank seminar participants at the University of California, Riverside, and at the 2014 Conference of the International Association for Applied Econometrics for helpful discussions. I am grateful to William A. Barnett (the Editor) and two anonymous referees for their comments and suggestions. An earlier version of this paper was circulated under the title “Money market implications of long run risk models”; I thank Ilaria Musumeci for her support in drafting the previous version of this work.

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