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The Role of Bounded Rationality in Macro-Finance Affine Term-Structure Models

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  • Tack Yun

    (Seoul National University)

  • Eunmi Ko

    (Seoul National University)

  • Jinsook Kim

    (Seoul National University)

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Abstract

Our goal in this paper is two-fold. First, we develop a class of term structure models that allow for the role of bounded rationality by incorporating either information-processing constraint or fear for mis-specification into affine term structure models. We indentify a set of sufficient conditions to generate the observational equivalence between affine term-structure models with rational inattention and a fear for model misspecification. The presence of bounded rationality creates a new additional factor that is not spanned by conventional factors such as level, slope, and curvature factors. Second, our empirical results indicate that substantial amounts of information capacity constraint and robustness preference for model misspecification are needed to explain the observed behavior of yields.

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Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 527.

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Date of creation: 2013
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Handle: RePEc:red:sed013:527

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  1. James D. Hamilton & Jing Cynthia Wu, 2011. "Testable Implications of Affine Term Structure Models," NBER Working Papers 16931, National Bureau of Economic Research, Inc.
  2. Greg Duffee, 2011. "Information in (and not in) the term structure," Economics Working Paper Archive 577, The Johns Hopkins University,Department of Economics.
  3. Scott Joslin & Kenneth J. Singleton & Haoxiang Zhu, 2011. "A New Perspective on Gaussian Dynamic Term Structure Models," Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 926-970.
  4. Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
  5. Michael D. Bauer & Glenn D. Rudebusch & Jing (Cynthia) Wu, 2011. "Unbiased estimate of dynamic term structure models," Working Paper Series 2011-12, Federal Reserve Bank of San Francisco.
  6. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, vol. 95(1), pages 138-160, March.
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Cited by:
  1. Luo, Yulei & Young, Eric, 2013. "Rational Inattention in Macroeconomics: A Survey," MPRA Paper 54267, University Library of Munich, Germany.

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