Evidence that Risk Adjustment is Unnecessary in Estimates of the User Cost of Money

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Diego A. Restrepo-Tobón


Money, User cost, Habit formation, Asset pricing


Investors value the  special attributes of monetary assets (e.g.,  exchangeability, liquidity, and safety)  and pay a premium for holding them in the form of a lower return rate. The user cost of holding monetary assets can be measured approximately by the difference between the  returns on illiquid risky assets and  those of safer liquid assets. A more appropriate measure should adjust this difference by the  differential risk of the  assets in question. We investigate the  impact that time  non-separable preferences has on the  estimation of the  risk-adjusted user cost of money. Using U.K. data from 1965Q1 to 2011Q1, we estimate a habit-based asset pricing model  with money  in the utility function and  find that the  risk  adjustment for risky monetary assets is negligible. Thus, researchers can dispense with risk adjusting the  user cost of money  in constructing monetary aggregate indexes.


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