IMF Working Papers

The Market Price of Risk and Macro-Financial Dynamics

By Tobias Adrian, Fernando Duarte, Tara Iyer

September 22, 2023

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Tobias Adrian, Fernando Duarte, and Tara Iyer. The Market Price of Risk and Macro-Financial Dynamics, (USA: International Monetary Fund, 2023) accessed November 21, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

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.

Subject: Asset prices, Consumption, Econometric analysis, Estimation techniques, Financial conditions index, Financial sector policy and analysis, National accounts, Prices, Structural vector autoregression

Keywords: Asset prices, Asset Pricing, Bond risk premia, Causal Identification, Consumption, Consumption Volatility, Contractionary monetary policy shock, Estimation techniques, Financial Conditions Index, Global, Macro-Finance, Market Price of Risk, Monetary Policy, Structural vector autoregression, Tightening of financial conditions, VFCI shock

Publication Details

  • Pages:

    87

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 2023/199

  • Stock No:

    WPIEA2023199

  • ISBN:

    9798400255397

  • ISSN:

    1018-5941

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