Unsecured Credit Supply Risk and Bond Prices

Abstract

Changes in credit supply induce large and frequent variations in households' access to unsecured debt. They generate a novel financial precautionary motive, which compounds the classical motive associated with idiosyncratic income risk, as borrowers accumulate risk-free bonds to hedge against them. Using a structural model, I estimate that this motive is an important driver of Treasury rates over the business cycle. It explains the historically low level of real rates in the last decade despite consumption growth, solving a "post-Great Recession risk-free rate puzzle". It is also critical for the volatility and comovement of household balance sheet and macroeconomic moments.