Hostname: page-component-669899f699-rg895 Total loading time: 0 Render date: 2025-04-24T17:28:38.816Z Has data issue: false hasContentIssue false
  • English
  • Français

Financial frictions, monetary policy, and the term premium

Published online by Cambridge University Press:  14 March 2025

Sungjun Huh  and
Insu Kim
Sungjun Huh
Affiliation:
Department of Economics, Konkuk University, Gwangjin-gu, Seoul, Republic of Korea
Insu Kim*
Affiliation:
Department of Economics, Jeonbuk National University, Jeonju-si, Jeollabuk-do, Republic of Korea
*
Corresponding author: Insu Kim; Email: insu.kim@jbnu.ac.kr
Get access Rights & Permissions [Opens in a new window]

Abstract

This study investigates the contribution of financial frictions in term premiums on long-term bonds within a production economy. We consider a New Keynesian model, featuring an agency problem between financial intermediaries and their private creditors and generalized recursive preferences. The model predicts that financial frictions that amplify the impact of structural shocks on key macroeconomic variables increase term premiums under our baseline calibration. Furthermore, financial frictions produce a larger term premium when monetary policy is geared toward output over inflation stability. The novel mechanism that financial frictions increase term premiums are associated with the bank balance sheet channel of monetary policy.

Keywords

Financial frictionsepstein-zin preferencesbond premiuminflation riskmoral hazardE32E44G12
Type
Articles
Information
Macroeconomic Dynamics , Volume 29 , 2025 , e82
Copyright
© The Author(s), 2025. Published by Cambridge University Press

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Article purchase

Temporarily unavailable

References

Adrian, T., Crump, R. K. and Moench, E.. (2013) Pricing the term structure with linear regressions. Journal of Financial Economics 110(1), 110–138.CrossRefGoogle Scholar
Andreasen, M. M. (2012) On the Effects of rare disasters and uncertainty shocks for risk premium and non-linear DSGE models. Review of Economic Dynamics 15(3), 295–316.CrossRefGoogle Scholar
Ang, A. and Piazzesi, M.. (2003) A no-arbitrage vector autoregression of the term structure dynamics with macroeconomic and latent variables. Journal of Monetary Economics 50(4), 745–787.CrossRefGoogle Scholar
Backus, D. K., Gregory, A. W. and Zin, S. E.. (1989) Risk premiums in the term structure: Evidence from artificial economies. Journal of Monetary Economics 24(3), 371–399.CrossRefGoogle Scholar
Bansal, R. and Yaron, A.. (2004) Risks for the long run: A potential resolution of asset pricing puzzles. The Journal of Finance 59(4), 1481–1509.CrossRefGoogle Scholar
Bansal, R. and Shaliastovich, I.. (2013) A long-run risks explanation of predictability puzzles in bond and currency markets. The Review of Financial Studies 26(1), 1–33.CrossRefGoogle Scholar
Barillas, F., Hansen, L. P. and Sargent, T. J.. (2009) Doubts or variability? Journal of Economic Theory 144(6), 2388–2418.CrossRefGoogle Scholar
Barsky, R. B., Juster, F. T., Kimball, M. S. and Shapiro, M. D.. (1997) Preference parameters and behavioral heterogeneity: An experimental approach in the health and retirement study. The Quarterly Journal of Economics 112(2), 537–579.CrossRefGoogle Scholar
Bernanke, B. S., Gertler, M. and Gilchrist, S.. (1999) Limited borrowing capacity of financial intermediaries in a quantitative business cycle framework. In: Handbook of Macroeconomics, vol. 1, pp. 1341–1393 CrossRefGoogle Scholar
Bigio, S. and Schneider, A.. (2017) Liquidity shocks, business cycles and asset prices. European Economic Review 97, 108–130.CrossRefGoogle Scholar
Bloom, N. (2009) The impact of uncertainty shocks. Econometric 77(3), 623–685.Google Scholar
Bluwstein, K. and Yung, J.. (2019) Back to the real economy: the effects of risk perception shocks on the term premium and bank lending. Bank of England Working Paper No. 806. Bank of EnglandCrossRefGoogle Scholar
Bundick, B., Herriford, T. and Smith, A. L.. (2017) Forward guidance, monetary policy uncertainty, and the term premium. Research Working Paper, RWP 17-7. Federal Reserve Bank of Kansas CityCrossRefGoogle Scholar
Caldara, D., Fernandez-Villáverde, J., Rubio-Ramírez, J. and Yao, W.. (2012) Computing DSGE models with recursive preferences and stochastic volatility. Review of Economic Dynamics 15(2), 188–206.CrossRefGoogle Scholar
Carlstrom, C. T. and Fuerst, T. S.. (1997) Agency costs, net worth, and business fluctuations: A computable general equilibrium analysis. American Economic Review 87(5), 893–910.Google Scholar
Christensen, I. and Dib, A.. (2008) The financial accelerator in an estimated New Keynesian model. Review of Economic Dynamics 11(1), 155–178.CrossRefGoogle Scholar
Christiano, L. J., Motto, R. and Rostagno, M.. (2014) Risk shocks. American Economic Review 104(1), 27–65.CrossRefGoogle Scholar
Creal, D. D. and Wu, J. C.. (2020) Bond risk premia in consumption-based models. Quantitative Economics 11(4), 1461–1484.CrossRefGoogle Scholar
Dedola, L., Karadi, P. and Lombardo, G.. (2013) Global implications of national unconventional policies. Journal of Monetary Economics 60(1), 66–85.CrossRefGoogle Scholar
den Haan, W. (1995) The term structure of interest rates in real and monetary economies. Journal of Economic Dynamics and Control 19(5-7), 909–940.CrossRefGoogle Scholar
Donaldson, J. B., Johnsen, T. and Mehra, R.. (1990) On the term structure of interest rates. Journal of Economic Dynamics and Control 14(3-4), 571–596.CrossRefGoogle Scholar
Epstein, L. G. and Zin, S. E.. (1989) Substitution, risk aversion, and the temporal behavior of consumption and asset returns: A theoretical framework. Econometrica 57(4), 937–969.CrossRefGoogle Scholar
Gerali, A., Neri, S., Sessa, L. and Signoretti, F. M.. (2010) Credit and banking in a DSGE model of the Euro area. Journal of Money, Credit and Banking 42(s1), 107–141.CrossRefGoogle Scholar
Gertler, M. and Kiyotaki, N.. (2015) Banking, liquidity and bank runs in an infinite-horizon economy. American Economic Review 105(7), 2011–2043.CrossRefGoogle Scholar
Gertler, M. and Karadi, P.. (2011) A model of unconventional monetary policy. Journal of Monetary Economics 58(1), 17–34.CrossRefGoogle Scholar
Gilchrist, S. and Leahy, J. V.. (2002) Monetary policy and asset prices. Journal of Monetary Economics 49(1), 75–97.CrossRefGoogle Scholar
Gomes, J. F., Yaron, A. and Zhang, L.. (2003) Asset prices and business cycles with costly external finance. Review of Economic Dynamics 6(4), 767–788.CrossRefGoogle Scholar
King, R. G. and Rebelo, S. T.. (1999) Chapter 14: Resuscitating real business cycles.  In: Handbook of Macroeconomics, vol. 1, Part B, Elsevier, pp. 927–1007CrossRefGoogle Scholar
Kiyotaki, N. and Moore, J.. (1997) Credit cycles. Journal of Political Economy 105(21), 211–248.CrossRefGoogle Scholar
Kiyotaki, N. and Moore, J.. (2012) Liquidity, business cycles, and monetary policy. National Bureau of Economic Research, Inc., NBER Working Papers: No. 17934CrossRefGoogle Scholar
Kung, H. (2015) Macroeconomic linkages between monetary policy and the term structure of interest rates. Journal of Financial Economics 115(1), 42–57.CrossRefGoogle Scholar
Livdan, D., Sapriza, H. and Zhang, L.. (2009) Financially constrained stock returns. The Journal of Finance 64(4), 1827–1862.CrossRefGoogle Scholar
Negro, D., Marco, M. P. G. and Schorfheide, F.. (2015) Inflation in the great recession and New Keynesian models. American Economic Journal: Macroeconomics 7(1), 168–196.Google Scholar
Nezafat, P. and Slavík, C.. (2015). Asset prices and business cycles with financial shocks. unpublished manuscript, Michigan State University and Goethe University Frankfurt. Available at SSRN: https://ssrn.com/abstract=1571754 Google Scholar
Nolan, C. and Thoenissen, C.. (2009) Financial shocks and the US business cycle. Journal of Monetary Economics 56(4), 596–604.CrossRefGoogle Scholar
Palomino, F. (2012) Bond risk pemiums and optimal monetary policy. Review of Economic Dynamics 15(1), 19–40.CrossRefGoogle Scholar
Piazzesi, M. (2005) Bond yields and the federal reserve. Journal of Political Economy 113(2), 311–344.CrossRefGoogle Scholar
Piazzesi, M. and Schneider, M.. (2007) Equilibrium Yield Curves. In: NBER Macroeconomics Annual 2006, vol. 21, pp. 389–472, National Bureau of Economic Research, Inc Google Scholar
Primiceri, G. E., Schaumburg, E. and Tambalotti, A.. (2006) Intertemporal disturbances. National Bureau of Economic Research, Inc., NBER Working Paper No. 12243CrossRefGoogle Scholar
Rudebusch, G. D. (2002) Term structure evidence on interest rate smoothing and monetary policy inertia. Journal of Monetary Economics 49(6), 1161–1187.CrossRefGoogle Scholar
Rudebusch, G. D. and Swanson, E. T.. (2012) The term premium in a DSGE model with long-run real and nominal risks. American Economic Journal: Macroeconomics 4(1), 105–143.Google Scholar
Shi, S. (2015) Liquidity, assets and business cycles. Journal of Monetary Economics 70, 116–132.CrossRefGoogle Scholar
Smets, F. and Wouters, R.. (2007) Shocks and frictions in US business cycles: A Bayesian DSGE approach. American Economic Review 97(3), 586–606.CrossRefGoogle Scholar
Swanson, E. T. (2015) A macroeconomic model of equities and real, nominal, and defaultable debt. Society for Economic Dynamics. 2015 Meeting Papers No. 273Google Scholar
Swanson, E. T., Anderson, G. S. and Levin, A. T.. (2006) Higher-order Perturbation Solutions to Dynamic, Discrete-time Rational Expectations Models. Federal Reserve Bank of San Francisco Working Paper No. 2006-01Google Scholar
Tallarini, T. D. (2000) Risk-sensitive real business cycles. Journal of Monetary Economics 45(3), 507–532.CrossRefGoogle Scholar
van, B., Jules, H., Fernández-Villaverde, J., Koijen, R. S. J. and Rubio-Ramírez, J.. (2012) The term structure of interest rates in a DSGE model with recursive preferences. Journal of Monetary Economics 59(7), 634–648.Google Scholar
Weil, P. (1989) The equity premium puzzle and the risk-free rate puzzle. Journal of Monetary Economics 24(3), 401–421.CrossRefGoogle Scholar
Wright, J. H. (2011) Term premia and inflation uncertainty: Empirical evidence from an international panel dataset. American Economic Review 101(4), 1514–1534.CrossRefGoogle Scholar
Supplementary material: File

Huh and Kim supplementary material

Huh and Kim supplementary material
Download Huh and Kim supplementary material(File)
File 192.5 KB