DP3041 Moral Hazard and the US Stock Market: The Idea of a 'Greenspan Put'

Author(s): Marcus Miller, Paul Weller, Lei Zhang
Publication Date: November 2001
Keyword(s): asset bubble, greenspan put, monetary policy, risk premium
JEL(s): D84, E52, G12
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3041

The risk premium in the US stock market has fallen far below its historic level, which Shiller (2000) attributes to a bubble driven by psychological factors. As an alternative explanation, we point out that the observed risk premium may be reduced by one-sided intervention policy on the part of the Federal Reserve which leads investors into the erroneous belief that they are insured against downside risk. By allowing for partial credibility and state dependent risk aversion, we show that this ?insurance? ? referred to as the Greenspan put ? is consistent with the observation that implied volatility rises as the market falls. Our bubble, like Shiller?s, involves market psychology: but what we describe is not so much ?irrational exuberance? as exaggerated faith in the stabilising power of Mr. Greenspan.