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The bond premium in a DSGE model with long-run real and nominal risks

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Author Info
Glenn Rudebusch
Eric Swanson

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Abstract

The term premium on nominal long-term bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data--an example of the ''bond premium puzzle.'' However, in models of endowment economies, researchers have been able to generate reasonable term premiums by assuming that investors have recursive Epstein-Zin preferences and face long-run economic risks. We show that introducing Epstein-Zin preferences into a canonical DSGE model can also produce a large and variable term premium without compromising the model's ability to fit key macroeconomic variables. Long-run real and nominal risks further improve the model's ability to fit the data with a lower level of household risk aversion.

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Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2008-31.

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Date of creation: 2008
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Handle: RePEc:fip:fedfwp:2008-31

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Keywords: Interest rates ; Econometric models;

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  34. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 825-853, August. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. François Gourio, 2009. "Disasters Risk and Business Cycles," NBER Working Papers 15399, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Jardet, C. & Monfort, A. & Pegoraro, F., 2009. "No-arbitrage Near-Cointegrated VAR(p) Term Structure Models, Term Premia and GDP Growth," Documents de Travail 234, Banque de France. [Downloadable!]
  3. Maarten Dossche, 2009. "Understanding inflation dynamics : Where do we stand ?," Research series 200906-11, National Bank of Belgium. [Downloadable!]
  4. Taeyoung Doh, 2008. "Long run risks in the term structure of interest rates: estimation," Research Working Paper RWP 08-11, Federal Reserve Bank of Kansas City. [Downloadable!]
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