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Dynamic bond portfolio choice in a model with Gaussian diffusion regimes

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  • Joao Liborio
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    Abstract

    This paper studies bond prices, intertemporal consumption and portfolio choice in a simple two-factor continuous-time regime-switching term structure model. The real interest rate and the expected inflation are modelled as an “extended” Ornstein-Uhlenbeck process, whose mean and variance shift randomly within a high-low Markovian regime. The prices of nominal and indexed bonds, the nominal and real term premia and the consumption-portfolio choice of a typical risk-averse investor are studied in the case in which the regime is observed.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/13518470500039287
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

    Volume (Year): 11 (2005)
    Issue (Month): 3 ()
    Pages: 259-270

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    Handle: RePEc:taf:eurjfi:v:11:y:2005:i:3:p:259-270

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    Related research

    Keywords: Portfolio choice; regime-switching models; term structure;

    References

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    1. Andrew Ang & Geert Bekaert, 1998. "Regime Switches in Interest Rates," NBER Working Papers 6508, National Bureau of Economic Research, Inc.
    2. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
    3. Martin Evans, 2002. "Real Risk, Inflation Risk, and the Term Structure," Working Papers gueconwpa~02-02-10, Georgetown University, Department of Economics.
    4. Garcia, R. & Perron, P., 1990. "An Anlysis Of The Real Interest Rate Under Regime Shifts," Papers 353, Princeton, Department of Economics - Econometric Research Program.
    5. David, Alexander, 1997. "Fluctuating Confidence in Stock Markets: Implications for Returns and Volatility," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 32(04), pages 427-462, December.
    6. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March.
    7. Hamilton, James D., 1988. "Rational-expectations econometric analysis of changes in regime : An investigation of the term structure of interest rates," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 385-423.
    8. Andrew Ang & Geert Bekaert, 2002. "International Asset Allocation With Regime Shifts," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1137-1187.
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