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Heterogeneous time preferences and interest rates--the preferred habitat theory revisited

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Frank Riedel

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Abstract

The influence of heterogeneous time preferences on the term structure is studied in the framework of a continuous-time pure exchange economy, in which agents have, apart from differential time preferences, the same degree of relative risk aversion. A closed-form solution for the financial equilibrium is obtained. In equilibrium, one long-term bond and one short-term bond form a complete market. Agents use these bonds to finance their consumption plans. The long-term bond is bought by agents with a long habitat. The short rate is a weighted average of the short rates which prevail in homogeneous economies populated by one type of agent only. It is shown by example that heterogeneity of time preferences can produce additional humps in the yield curve.

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Publisher Info
Article provided by Taylor and Francis Journals in its journal The European Journal of Finance.

Volume (Year): 10 (2004)
Issue (Month): 1 (February)
Pages: 3-22
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Handle: RePEc:taf:eurjfi:v:10:y:2004:i:1:p:3-22

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Related research
Keywords: Time Preferences; Term Structure; Interest Rates; Preferred Habitat Theory; Heterogeneity;

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References listed on IDEAS
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  1. Duffie, Darrell & Skiadas, Costis, 1994. "Continuous-time security pricing : A utility gradient approach," Journal of Mathematical Economics, Elsevier, vol. 23(2), pages 107-131, March. [Downloadable!] (restricted)
  2. Constantinides, George M & Duffie, Darrell, 1996. "Asset Pricing with Heterogeneous Consumers," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 219-40, April. [Downloadable!] (restricted)
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  3. Detemple Jerome & Murthy Shashidhar, 1994. "Intertemporal Asset Pricing with Heterogeneous Beliefs," Journal of Economic Theory, Elsevier, vol. 62(2), pages 294-320, April. [Downloadable!] (restricted)
  4. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November. [Downloadable!] (restricted)
  5. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1981. "A Re-examination of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 36(4), pages 769-99, September. [Downloadable!] (restricted)
  6. Dumas, Bernard, 1989. "Two-Person Dynamic Equilibrium in the Capital Market," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 2(2), pages 157-88. [Downloadable!] (restricted)
  7. Dybvig, Philip H & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1996. "Long Forward and Zero-Coupon Rates Can Never Fall," Journal of Business, University of Chicago Press, vol. 69(1), pages 1-25, January. [Downloadable!] (restricted)
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  8. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 3(4), pages 573-92. [Downloadable!] (restricted)
  9. Bakshi, Gurdip S. & Zhiwu, Chen, 1997. "An alternative valuation model for contingent claims," Journal of Financial Economics, Elsevier, vol. 44(1), pages 123-165, April. [Downloadable!] (restricted)
  10. Sun, Tong-sheng, 1992. "Real and Nominal Interest Rates: A Discrete-Time Model and Its Continuous-Time Limit," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 5(4), pages 581-611. [Downloadable!] (restricted)
  11. Jiang, Wang, 1996. "The term structure of interest rates in a pure exchange economy with heterogeneous investors," Journal of Financial Economics, Elsevier, vol. 41(1), pages 75-110, May. [Downloadable!] (restricted)
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