Charles Explorer logo
🇬🇧

Investor sentiment and efficiency of central banks' response to financial crisis

Publication

Abstract

The recent unconventional monetary policy of the ECB and the Fed has stimulated an ongoing debate about the proper policy instruments to mitigate economic crises. The debate has revealed that existing macroeconomic models do not account for many aspects of financial crisis, including increased credit spreads, role of agents' expectations in market volatility or over-pessimism of investors' forecasts.

In this paper we build a theoretical model which accommodates such features of the financial market as heterogeneous forecasts, both liquidity and default risk for the banking sector and collateral constraints. We show that in a set-up with risk-averse investors with heterogeneous beliefs, intermediaries tend to be over-pessimistic in times of crisis and underinvest, and that effect of central banks' policy is undermined.