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The Consumption-Based Determinants of the Term Structure of Discount Rates

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  • Christian Gollier

Abstract

The efficient rate of return of a zero-coupon bond with maturity t is determined by our expectations about the mean (+), variance (-) and skewness (+) of the growth of aggregate consumption between 0 and t . The shape of the yield curve is thus determined by how these moments vary with t . We first examine growth processes in which a higher past economic growth yields a first-degree dominant shift in the distribution of the future economic growth, as assumed for example by Vasicek (1977). We show that when the growth process exhibits such a positive serial correlation, then the yield curve is decreasing if the representative agent is prudent ( u''' > 0), because of the increased risk that it yields for the distant future. A similar definition is proposed for the concept of second-degree stochastic correlation, as observed for example in the Cox-Ingersoll-Ross model, with the opposite comparative static property holding under temperance ( u''''

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1375.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1375

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Keywords: stochastic dominance; yield curve; far distant future; cost-benefit analysis; prudence; temperance; downside risk;

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  1. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  2. Menezes, C & Geiss, C & Tressler, J, 1980. "Increasing Downside Risk," American Economic Review, American Economic Association, vol. 70(5), pages 921-32, December.
  3. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
  4. Cogley, T., 1989. "International Evidence On The Size Of The Random Walk In Output," Discussion Papers in Economics at the University of Washington 89-02, Department of Economics at the University of Washington.
  5. Martin L. Weitzman, 2001. "Gamma Discounting," American Economic Review, American Economic Association, vol. 91(1), pages 260-271, March.
  6. Gollier, Christian, 2002. "Discounting an uncertain future," Journal of Public Economics, Elsevier, vol. 85(2), pages 149-166, August.
  7. Kocherlakota, N., 1995. "The Equity Premium: It's Still a Puzzle," Working Papers 95-05, University of Iowa, Department of Economics.
  8. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  9. EECKHOUDT, Louis & Christian GOLLIER & Thierry SCHNEIDER, 1994. "Risk Aversion, Prudence and Temperance : A Unified Approach," Working Papers 006, Risk and Insurance Archive.
  10. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  11. Weitzman, Martin L., 1998. "Why the Far-Distant Future Should Be Discounted at Its Lowest Possible Rate," Journal of Environmental Economics and Management, Elsevier, vol. 36(3), pages 201-208, November.
  12. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-84, March.
  13. Gollier, Christian, 2002. "Time Horizon and the Discount Rate," Journal of Economic Theory, Elsevier, vol. 107(2), pages 463-473, December.
  14. Pizer, William & Newell, Richard, 2000. "Discounting the Distant Future: How Much Do Uncertain Rates Increase Valuations?," Discussion Papers dp-00-45, Resources For the Future.
  15. Robert B. Barsky, 1986. "Why Don't the Prices of Stocks and Bonds Move Together?," NBER Working Papers 2047, National Bureau of Economic Research, Inc.
  16. David K. Backus & Silverio Foresi & Chris Telmer, . "Discrete time models of bond pricing," GSIA Working Papers 251, Carnegie Mellon University, Tepper School of Business.
  17. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 893-920, October.
  18. Estrella, Arturo & Hardouvelis, Gikas A, 1991. " The Term Structure as a Predictor of Real Economic Activity," Journal of Finance, American Finance Association, vol. 46(2), pages 555-76, June.
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