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Risk Aversion, Intertemporal Substitution, and the Term Structure of Interest Rates

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  • René Garcia
  • Richard Luger

Abstract

We build and estimate an equilibrium model of the term structure of interest rates based on a recursive utility specification. We contrast it with an arbitrage-free model, where prices of risk are estimated freely without preference constraints. In both models, nominal bond yields are affine functions of macroeconomic state variables. The equilibrium model accounts for the tent-shaped pattern and magnitude of coefficients from predictive regressions of excess bond returns on forward rates and the hump-shaped pattern in the term structure of volatilities, while the reduced-form no-arbitrage model does not account for these important features of the yield curve. Nous construisons et évaluons un modèle d’équilibre de la structure par terme des taux d’intérêt, fondé sur une caractéristique de la fonction d’utilité récursive. Nous le comparons à un modèle caractérisé par l’absence d’arbitrage, dans lequel les prix du risque sont estimés librement sans contrainte de préférence. Dans les deux modèles, les rendements des obligations nominales sont des fonctions affines des variables d’état macroéconomique. Le modèle d’équilibre prend en compte le profil en forme de tente (tent-shaped) et l’ampleur des coefficients de régression prédictive relatifs aux rendements des obligations excédant les taux d’intérêt à terme, de même que le profil en forme de bosse (hump-shaped) dans la structure par terme des volatilités, tandis que le modèle à forme réduite et caractérisé par l’absence d’arbitrage ne tient pas compte de ces caractéristiques importantes de la courbe de rendement.

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Bibliographic Info

Paper provided by CIRANO in its series CIRANO Working Papers with number 2009s-20.

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Date of creation: 01 May 2009
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Handle: RePEc:cir:cirwor:2009s-20

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Keywords: Recursive utility; Yield curve; Affine macro-finance model; Bond risk premium; Expectations puzzle; Utilité récursive; courbe de rendement; modèle macrofinancier affine; prime de risque liée aux obligations; perplexité des attentes;

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Cited by:
  1. Jardet, C. & Monfort, A. & Pegoraro, F., 2009. "No-arbitrage Near-Cointegrated VAR(p) Term Structure Models, Term Premia and GDP Growth," Working papers 234, Banque de France.
  2. Gregory H. Bauer & Antonio Diez de los Rios, 2012. "An International Dynamic Term Structure Model with Economic Restrictions and Unspanned Risks," Working Papers 12-5, Bank of Canada.

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