A1255
Title: Quantitative easing of fear during rare disasters
Authors: Go Charles-Cadogan - University of Leicester (United Kingdom) [presenting]
Abstract: A natural experiment is conducted in which the US Federal Reserve money supply M1SL (M1SL) response to the Great Recession of 2008 is a control, and its M1SL response to the exogenous COVID-19 pandemic event is a treatment for the Great Lockdown of 2020. Both recession periods are matched on market crashes from rare disasters, almost identical VIX scores, similar jumps in risk aversion, similar U-shape patterns in US Treasury yield curves, and similar intertemporal marginal rate of substitution (IMRS) behaviour. The main difference is the Feds' unprecedented M1SL treatment of the Great Lockdown compared to the Great Recession of 2008 (and other rare disasters). A novel time-varying stochastic discount factor (SDF) is introduced, which admits explosions based on fear of catastrophic loss in financial markets, and it disentangles risk aversion from fear of loss. It is found that even though both rare disasters were matched on risk attitudes and consumption behaviour, the unprecedented increase in M1SL treatment during the Great Lockdown is aliasing for fear of loss like that observed during the Great Recession. The treatment is tantamount to latent risk substitution that attenuated the SDF during the V-shaped Great Lockdown recession. The risk substitution is confirmed by a difference-in-difference analysis.
