Magazine article Economic Trends

Money and Financial Markets

Magazine article Economic Trends

Money and Financial Markets

Article excerpt

In a recent speech, Federal Reserve Board Governor Donald Kohn noted that the Federal Reserve pays "a lot of attention to financial market prices the formulation of monetary policy." He goes on to say that "[a]n important element in interpreting financial market prices is the identification of the risk premiums they contain." By risk premium, Governor Kohn means the additional return required by investors for holding a risky security above the compensation that would be demanded by risk-neutral investors, who care only about expected returns.

More specifically, Governor Kohn thinks of risk premiums as "the extra compensation for the uncertainty" around anticipated economic and financial outcomes. This compensation is determined by both perception of and investor preferences, or risk aversion." Estimates Of the risk premiums for bonds and equity have declined since the 1970s, when the economy was experiencing high inflation, Although the equity premium is lower now than in the early 1960s (before Me great inflation), the bond premium is not. The decline in equity yields over time reflects, to some extent, the markedly reduced variability of both inflation and economic activity that occurred around the mid-1980s, when inflation brought under control.

Expectations for longer-term inflation can he derived from the difference between the yield on a Treasury bond and the yield on a Treasury inflation-protected security (TIPS) of the same maturity, adjusted for its liquidity premium. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.