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The Term Structure of Real Interest Rates: Theory and Evidence from UK Index-Linked Bonds

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  • Seppälä, Juha

    ()
    (Bank of Finland Research (Visiting Scholar))

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    Abstract

    This paper studies the behavior of the default-risk-free real term structure and term premia in two general equilibrium endowment economies with complete markets but without money. In the first economy there are no frictions as in Lucas (1978) and in the second risk-sharing is limited by the risk of default as in Alvarez and Jermann (2000ab). Both models are solved numerically, calibrated to UK aggregate and household data, and the predictions are compared to data on real interest rates constructed from the UK index-linked data. While both models produce time-varying risk or term premia, only the model with limited risk-sharing can generate enough variation in the term premia to account for the rejections of expectations hypothesis.

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    File URL: http://www.suomenpankki.fi/en/julkaisut/tutkimukset/keskustelualoitteet/Documents/0022.pdf
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    Bibliographic Info

    Paper provided by Bank of Finland in its series Research Discussion Papers with number 22/2000.

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    Length: 61 pages
    Date of creation: 29 Dec 2000
    Date of revision:
    Handle: RePEc:hhs:bofrdp:2000_022

    Contact details of provider:
    Postal: Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland
    Web page: http://www.suomenpankki.fi/en/
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    Related research

    Keywords: term structure of interest rates; general equilibrium; default risk; term premia; index-linked bonds;

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    Cited by:
    1. Ravenna , Federico & Seppälä , Juha, 2006. "Monetary policy and rejections of the expectations hypothesis," Research Discussion Papers 25/2006, Bank of Finland.
    2. Scheffel, Eric, 2008. "A Credit-Banking Explanation of the Equity Premium, Term Premium, and Risk-Free Rate Puzzles," Cardiff Economics Working Papers E2008/30, Cardiff University, Cardiff Business School, Economics Section.

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