Article ID Journal Published Year Pages File Type
5066946 European Economic Review 2013 16 Pages PDF
Abstract

•The effect of interest rates on risk taking is fundamentally ambiguous, and depends on the sources of risk.•At low interest rates, investors favor opaque investment projects that are perceived to be fundamentally safe.•At high interest rates, investors favor transparent projects that are fundamentally risky.

We explore the effect of interest rates on risk taking and find that it depends on the type of risk involved. In a Bayesian setting, investments can be risky either because payoff-relevant signals are noisy or because the dispersion of the prior is high. While both types of risk contribute symmetrically to the overall riskiness of an investment project, we show that changes in interest rates affect risk taking in these two types of risk in opposite directions. This makes the net effect of interest rates on risk taking-as measured by the average riskiness of financed projects-necessarily ambiguous and dependent on the sources of risk.

Related Topics
Social Sciences and Humanities Economics, Econometrics and Finance Economics and Econometrics
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