tag:blogger.com,1999:blog-8152901575140311047.post6620108968017754414..comments2024-03-29T07:41:47.433-04:00Comments on Musings on Markets: Negative Interest Rates: Impossible, Unnatural or Just Unusual?Aswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comBlogger35125tag:blogger.com,1999:blog-8152901575140311047.post-9054669792367481602018-07-25T21:40:07.563-04:002018-07-25T21:40:07.563-04:00Dear Professor,
I have a question about the compo...Dear Professor,<br /><br />I have a question about the components of interest rate. What you have said in your paper is that the intrinsic value of interest rate includes the expected inflation, the default risk premium and the real interest rate. However, what I studied in corporate finance about the term structure of interest rate, it said that the interest rate has 1 more component: the interest rate risk premium, which means comparing the 10-year treasury bond and 1-year treasury bond, the change in interest rate will affected the price of 10-year treasury bond more than 1-year treasury bond. The investor, then, requires a premium for the uncertainty of the 10-year bond. When I tried to match 2 source of information together, I was confused how should I understand the interest rate risk premium, should it be included in the intrinsic value of interest rate.<br />Thanks Professor<br />CharlieCharlienoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-32534849014888973992016-10-06T06:41:08.626-04:002016-10-06T06:41:08.626-04:00Hi Professor,
I am working in a valuation team in...Hi Professor,<br /><br />I am working in a valuation team in HK. Thanks for your sharing. <br /><br />I understand negative interest rate will not do impact a lot in valuing equity at this moment given the discount rate would include market risk premium and other adjustments. However, I would like to know if we are valuing a bond, say a USD or JPY denominated bond with 5-10 year tenor with AAA credit rating, what kind of discount rate should I use if there is a negative interest rate for corporate bonds with similar rating?<br /><br /><br />Thanks a lot!Poor Charliehttps://www.blogger.com/profile/07829243968022867301noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-35497184139733688602016-08-04T10:37:55.078-04:002016-08-04T10:37:55.078-04:00I am an Adjunct Faculty at the Singapore Managemen...I am an Adjunct Faculty at the Singapore Management University. I teach a Global Macro curse for Students of Wealth Management Programme (Master's; one-year). We have had detailed discussions on the global crisis, negative rates, etc. in the last few days. I wanted to provide them more references. The piece by Kevin Warsh and Michael Spence last October and then your blog post in March this year came to mind. I had also blogged on your post in March itself. Just in case you are curious, here is the link:<br /><br />https://thegoldstandardsite.wordpress.com/2016/03/15/aswath-damodaran-on-negative-rates/<br /><br />Today, Bank of England cut rates to 0.25% and promised to bring it close to zero in future.Unknownhttps://www.blogger.com/profile/16978858400004505965noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-36333334435041344712016-06-25T09:37:27.712-04:002016-06-25T09:37:27.712-04:00An excellent article! But there is one fundamental...An excellent article! But there is one fundamental issue that I have been grappling with over the past few days. There has been so much talk about natural real interest rates being negative over various periods in history (including the post 2008 crisis period). But I somehow am not able to understand the concept of a negative real/natural interest rate. To my mind, it should not be possible. In a world devoid of currencies, it is equivalent to, say, lending 10 bushels of wheat to receive 9 bushels after one year. Even with the costs of storage, I feel it is simply not compatible with human behaviour (which is the trigger for all economic activities). <br /><br />I would be glad to hear your views on this!Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-81041468760622136412016-04-07T16:13:10.410-04:002016-04-07T16:13:10.410-04:00Thank you for this excellent article. Another inte...Thank you for this excellent article. Another interesting question would be how much lower the ECB can push interest rates. If the interest rates are very negative, please will take Cash out of the bank accounts and put the money in there cushions.<br /><br />Big insurance companies such as Munich Re in Germany are already hording gold and cash in order to avoid the negative interest:<br /><br />http://www.sueddeutsche.de/wirtschaft/munich-re-rueckversicherer-bunkert-gold-in-geheimem-tresor-1.2909890Patent Anmeldenhttp://www.franke-ip.comnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-7265882321460664622016-04-02T10:37:32.488-04:002016-04-02T10:37:32.488-04:00Professor,
Thanks for your reply and sorry for my ...Professor,<br />Thanks for your reply and sorry for my late reply! I looked up the excel sheet of yours in which the ERPs were given. Taking the average ERP from 2008-'15 (post crisis stage) shows that the ERPs post the move into QE in two stages of QE from 2009-11 (QE1) and in 2013 (QE3) was actually lesser than the average being 5.58% indicating that the moves into QE compressed ERPs. Beyond that, I agree with what you spoke on Bloomberg TV in an interview which indicated that equities have largely been pushed up by Wall Street analysts over the last few years which justifies overshooting fundamentals. Coupling both tells me that it's not just risk premiums were low post QE but also that they weren't a consideration for a trader driven market - implying that risk premiums were relatively low (higher highs in asset prices generated by analysts) but on an absolute basis stubbornly high as you mentioned.<br />The above may or may not be true but is just my interpretation.<br />Thank you Professor.Anonymoushttps://www.blogger.com/profile/13126206248978407581noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-18586798935339736892016-03-22T16:48:11.620-04:002016-03-22T16:48:11.620-04:00Amruth,
Not a bad argument but one fundamental pro...Amruth,<br />Not a bad argument but one fundamental problem. If risk premiums are compressed, where is the evidence that they are? My implied ERP has remained stubbornly high for the last six years.Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-15845272327878292902016-03-22T14:43:01.352-04:002016-03-22T14:43:01.352-04:00Great post Professor! About risk premiums I would ...Great post Professor! About risk premiums I would just like to add that QE had done enough to inflate asset prices like equities thereby compressing risk premiums and probably making them run above their fundamentals. Negative rates possibly can't lift asset prices since QE already did it and thus we see equities falling and risk premiums widening yet again. If QE and NIRP had initially come together but in a stable manner risk premiums could've actually fallen. Anyway it's anybody's guess and hindsight views! Thanks again for the post Professor!Amruthnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-79382367036562037122016-03-21T07:03:11.842-04:002016-03-21T07:03:11.842-04:00In your title, you ask the question of whether rat...In your title, you ask the question of whether rates are "unnatural", and you come close to answering in the "...signify" section, but in the end are inconclusive.<br /><br />The key, I think, is the realization that while central bankers are clearly not impotent, they are not central planners. In fact, they are conservative and reactive, while also being over-optimistic and negligent or ignorant of risks. They don't set interest rates so much as have their decisions guided by developments, many outside of their control; I think you got that much right when you brought them into the picture. They look like they are active, but they are in fact timid -- think about the BoE leaving rates at 0.50%, and the Fed's premature withdrawals of QE1 and QE2.<br /><br />Kocherlakota's blog-posts are a good read, and illustrate that negative rates are in fact, as you suggest, a pretty small change from low but positive rates. A bit of extra policy space, but no game changer: that would mean helicopter drops and/or fiscal policy. Again, Bernanke's 2002 speech reminded EVERYONE that this should be that natural way to go. And chronically low or negative rates are a result of, not a cause of (a) previous monetary failures and (b) current conditions including fiscal settings and private sector actions. Negative rates and QE are a normal -- not an abnormal -- setting when the demand for savings is high and the willingness/ability to invest is low. That's the reality today. Change that and rates will go up.David Nowakowskinoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-51986281696738859102016-03-16T06:30:39.199-04:002016-03-16T06:30:39.199-04:00It is great post and some great responses from Pro...It is great post and some great responses from Professor Aswath Damodaran. Professor might be interested to note that Raghuram Rajan holds not-so-dissimilar views and he may also find thes two blog posts by Noah Smith in Bloomberg - great reads:<br /><br />http://www.bloombergview.com/articles/2014-11-04/reality-might-topple-a-beloved-economic-theory<br /><br />and http://www.bloombergview.com/articles/2016-03-10/an-economics-laboratory-where-theories-go-to-die<br /><br />The anonymous gentleman/woman who suggests that low interest rates always lead to deterministic outcomes has forgotten the basic lesson of economic theories. They are valid as long as everything else stays constant. But, nothing ever stays constant. There is unintended signalling from negative interest rates. If real rates are constant and are determined by consumption and social preferences, negative policy rates must result in expected deflation.<br /><br />Further, empirical evidence (Federal Reserve discussion paper from Dec. 2013) is that corporate CFOs rarely bring down their hurdle rates when interest rates drop. So, investment spending does not respond to lower interest rates as much as theory would predict. IT is consumer spending that is sought to be given a push. <br /><br />Whether that is desirable in the US context is entirely debatable.<br /><br />It is good that Prof. Aswath Damodaran has lent his considerable intellectual reputation to the cause of righting hubristic monetary policies. World over, monetary policymakers can do with a lot less certitude and with lot more mindfulness of the law of unintended consequences.Unknownhttps://www.blogger.com/profile/16978858400004505965noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-51686718193056851782016-03-15T16:38:29.016-04:002016-03-15T16:38:29.016-04:00Just because someone writes it in an economists...Just because someone writes it in an economists' blog does not make it true. If it were, we should be in the middle of astonishing economic growth, after six years of rate cuts. And only people who do not understand and respect markets (and I include many academic economists in this camp) use words like always, when it comes to market behavior. An unexpected rate cut always causes stock prices to rise: Really? What absolute nonsense? (Look at the rate cuts that happened between October and December of 2008 for simple counter examples)Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-68222942105585970912016-03-15T14:48:02.923-04:002016-03-15T14:48:02.923-04:00More on recent rate moves + market reactions:
htt...More on recent rate moves + market reactions:<br /><br />http://econlog.econlib.org/archives/2016/03/the_medias_blin.html<br /><br />I don't think there's any argument to be made that interest rate cuts aren't expansionary (a good thing, since it would fly in the face of macro theory). Markets always react to unexpected rate cuts by pushing asset prices up.<br /><br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-30282888619963626352016-03-15T12:55:46.836-04:002016-03-15T12:55:46.836-04:00Thank you for a nice article. A follow-up could de...Thank you for a nice article. A follow-up could deal with the role of the central banks more fully. What have they achieved and what motivates them? Since most of them operate in an explicit or implicitly unaccountable space and they control such vast amounts, these are questions that any democracy need to be answered, particularly in the context of a financial sector that is out of control. Tim ExallAnonymoushttps://www.blogger.com/profile/04202232285776343744noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-20997075499833591602016-03-15T12:03:54.606-04:002016-03-15T12:03:54.606-04:00A few comments:
There's another driver for lo...A few comments:<br /><br />There's another driver for long term rates which you don't mention. That is the assumed cost of funding, stemming from no-arb markets theory. I.e. Say that for term T, inflation is X, and real-rate demanded by investors is Y. So you have I = X+Y. But if the short-term rate is S << I, and the CBs indicate that for a large part of T (if not whole of T) S is going to be the same, then there's an abitrage profit to be made by buying the bond with yield I and funding it at rolled S (or S + short-term funding spread). Of course, you're running a risk of CB lying (SNB Jan 2015 is an example), and you getting hit regardless, but again, if swaps are cheap, you may be able to hedge the your funding there.<br /><br />Which of the drivers takes the driving seat depends on their market strenghts. Given that speculators trade more often than real money, and in general are more active in just about all but commodities, I believe that it's currently more likely that the yields are driven by the short rates rather than inflation or whatever else. <br /><br />Second point is re CBs driving investment. CB's are detached from reality, because in reality the decision of a project to go/not go is not determined by costs alone, but by potential revenues. Reducing costs may make some marginal project viable, ceteris paribus. But there's never ceteris. So, in an environment where demand is slowing considerably, reducing costs marginally is unlikely to be enough to make even marginal projects interesting. Definitely not unless you reduce your expected RoI substantially. But if your expected RoI was say 15% before 2008, with 5% long-term rates, you have 10% of risk premia. If the project was not started at 2% long term rates, it's unlikely that reducing the long term rates to 0% will start it, especially if it's accompanied by the projections of demand going down by say 3-5% (which is the difference between economy growing at 3-5% and being flat). Talk about pushing a string.<br /><br />The projects that low rates will encourage are thus those where a formal estimate of RoI and viability is not done (or cannot be done with any degree of accuracy, and that's saying something) - like buying more rental flats, startup investing, anything that can generate a lots of cash up front in exchange for a huge debt load etc. - the very riskiest stuff. Some of this may very well pay out long term, but the payout is likely concentrated to a specific group of people (house owners with mortgages, landlords, some VCs/startup founders etc.), which is not necessarily a good outcome either.<br /><br /><br />vladenoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-46860713845227450622016-03-14T23:38:45.617-04:002016-03-14T23:38:45.617-04:00"If you go outside the US, there is evidence ..."If you go outside the US, there is evidence that repeated rate cuts do more damage than good to financial asset markets in Japan and Europe"<br /><br />Again, I think you're mixing cause and effect here. Japan has had to cut rates *because* the economy has been so dismal, not vice versa. I would make the argument that the natural rate of interest is so low in Japan that even the low interest rates they had through the 2000's were keeping conditions far too tight.<br /><br />The recent, much-discussed Beckworth/Ponnuru article in the NYT does a good job explaining that interest rates at their face value mean little, it is the spread between the natural / wicksellian interest rate and the target rate that determines whether money is tight or loose. <br /><br />Bernanke argues the same thing:<br /><br />"The imperfect reliability of money growth as an indicator of monetary policy is unfortunate, because we don't really have anything satisfactory to replace it. As emphasized by Friedman (in his eleventh proposition) and by Allan Meltzer, nominal interest rates are not good indicators of the stance of policy, as a high nominal interest rate can indicate either monetary tightness or ease, depending on the state of inflation expectations. Indeed, confusing low nominal interest rates with monetary ease was the source of major problems in the 1930s, and it has perhaps been a problem in Japan in recent years as well."<br /><br />and from Mishkin's textbook (THE book on monetary policy):<br /><br />"1. It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.<br /><br />2. Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.<br /><br />3. Monetary policy can be highly effective in reviving a weak economy even if short term rates are already near zero."<br /><br /><br /><br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-16618551293447458852016-03-14T15:23:18.240-04:002016-03-14T15:23:18.240-04:00You are right. The ECB did push their rate from -3...You are right. The ECB did push their rate from -30 basis points to -40 basis points last week and I think I have a note to that effect in the post.Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-64691905306377357732016-03-14T14:20:43.924-04:002016-03-14T14:20:43.924-04:00Didn't the ECB take their deposit rate from -3...Didn't the ECB take their deposit rate from -30 bps to -40 bps last week? As such weren't they already negative?<br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-19526986099605278252016-03-14T08:25:26.045-04:002016-03-14T08:25:26.045-04:00Anonymous,
My statement on the market reaction to ...Anonymous,<br />My statement on the market reaction to interest rate cuts by the central bank is a conditional one. I said that if markets view a cut in rates as a sign that things are worse than expected, stock and bond prices will go down. Your point about the data not backing that up is true for the United States for much of the last century. If you go outside the US, there is evidence that repeated rate cuts do more damage than good to financial asset markets in Japan and Europe, and even within the US, the Fed's capacity to move markets has become much, much weaker since 2008. In fact, almost every assessment of the Fed effect is dramatically different if you look at the period prior to 2008 and post-2008.Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-2660944450538840152016-03-14T08:01:10.710-04:002016-03-14T08:01:10.710-04:00Sir,
I was looking on your views regarding the new...Sir,<br />I was looking on your views regarding the new negative interest rate regimes. Negative interest rates are the new experiment in the Central Banking. However, I am very confused as to how this will prop up real economy?<br />The asset bubbles it would lead to afterwards seems to be massive as the same was happened when US tried QE as most of the benefit of it transferred in propping up asset prices. As far as real economy is concerned, the corporates and individual businesses will not simply invest their free cash on the sole reason of low interest rates.<br />Would like to have your take on this issue.<br /><br />ThanksMy Experience with Lifehttps://www.blogger.com/profile/13255799569408971413noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-9951404883506265422016-03-13T18:37:49.233-04:002016-03-13T18:37:49.233-04:00"If the lowering of rates by a central bank a..."If the lowering of rates by a central bank are viewed as a sign that the economy is in bigger trouble than you thought is was, the risk premiums for debt and equity can go up by more than rates go down. Net result. Stock and bond prices will drop, not go up, as central banks lower rates."<br /><br />This isn't borne out in the data that I've seen. Interest rate cuts that take the market by surprise virtually always see a spike in asset prices. The idea that interest rate cuts are contractionary (aka the Neo-Fisherian view) just doesn't have any evidence behind it. Your theory implies that the Fed knows something the market doesn't, but usually it's the exact oppositeAnonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-56189034337157265602016-03-13T18:10:52.436-04:002016-03-13T18:10:52.436-04:00Thank you for another excellent post, professor. O...Thank you for another excellent post, professor. Only one question and sorry if this information is already on your website: in your estimate/calculation of historic equity risk premiums, can you help me understanding how you determined the "Expected Return on Stocks"? Thank you!Bernd Schmidhttps://www.blogger.com/profile/08900439424888762245noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-60834279258374430372016-03-13T11:48:16.378-04:002016-03-13T11:48:16.378-04:00Prof, your argument regarding intrinsic interest r...Prof, your argument regarding intrinsic interest rate holds perfectly well for US markets. However, for an emerging market like say, India, it has not worked that well. If you take real growth rate and inflation rate year on year for India and compare to the government bond rate, the gap is pretty large. Could you please explain why? Thanks. Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-45378740900372922272016-03-13T10:29:02.480-04:002016-03-13T10:29:02.480-04:00Sid,
The answer is no, since the average beta is a...Sid,<br />The answer is no, since the average beta is always one. Hence, the betas for all stocks cannot increase.Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-40073427266628306942016-03-13T09:11:48.523-04:002016-03-13T09:11:48.523-04:00Sir, would it not be more correct to say that beta...Sir, would it not be more correct to say that beta of the stocks increases (in such cases) in place of saying that equity risk premium goes up? Sidhttps://www.blogger.com/profile/06352348330853788766noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-53058130767973172322016-03-13T08:02:30.618-04:002016-03-13T08:02:30.618-04:00Sid,
When stock and bond prices fall, equity risk ...Sid,<br />When stock and bond prices fall, equity risk premiums and default spreads go up.Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.com