Comment

Abstract

This ingenious paper by Koslowski, Veldkamp, and Venkateswaran develops a model with two main components. The first is rooted in the financial economics of asset pricing. It describes amechanism linking bad financial experiences to lengthy periods of low riskless interest rates. The second is rooted in corporate finance. It considers features of financial institutions and markets that explain why safe assets enjoy a larger increase in value in bad times than is captured in standard asset pricing models. I will start by exploring the simple two-period, two-state Lucas (1978) model of asset pricing to develop a sense of the challenges in understanding the pricing of risky and riskless assets. Investor households receive 1 unit of endowment to consume now and a random endowment with two possible values to consume in the future, c1 and c2 in states 1 and 2. State 1 is normal and state 2 is a disasterwith considerably lower consumption. The probabilities of the two consumption levels are 1 p and p, respectively. These two values of possible consumption are constrained so that expected consumption growth is at a designated rate g: