Ambiguity Aversion and the Term Structure of Interest Rates
AbstractThis paper studies the term structure implications of a simple structural economy in which the representative agent displays ambiguity aversion, modeled by Multiple Priors Recursive Utility. Bond excess returns reflect a premium for ambiguity, which is observationally distinct from the risk premium of affine yield curve models. The ambiguity premium can be large even in the simplest logutility model and is non zero also for stochastic factors that have a zero risk premium. A calibrated low-dimensional two-factor economy with ambiguity is able to reproduce the deviations from the expectations hypothesis documented in the literature, without modifying in a substantial way the nonlinear mean reversion dynamics of the short interest rate. In this economy, we do not find any apparent tradeoffs between fitting the first and second moments of the yield curve and the large equity premium.
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Bibliographic InfoPaper provided by Department of Economics, University of St. Gallen in its series University of St. Gallen Department of Economics working paper series 2007 with number 2007-29.
Length: 45 pages
Date of creation: Jul 2007
Date of revision:
General Equilibrium; Term Structure of Interest Rates; Ambiguity Aversion; Expectations Hypothesis; Campbell-Shiller Regression;
Other versions of this item:
- Patrick Gagliardini & Paolo Porchia & Fabio Trojani, 2009. "Ambiguity Aversion and the Term Structure of Interest Rates," Review of Financial Studies, Society for Financial Studies, vol. 22(10), pages 4157-4188, October.
- Laurent BARRAS & Patrick Gagliardini & Paolo Porchia & Fabio Trojani, . "Ambiguity Aversion and the Term Structure of Interest Rates," Swiss Finance Institute Research Paper Series 08-18, Swiss Finance Institute.
- C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-08-14 (All new papers)
- NEP-DGE-2007-08-14 (Dynamic General Equilibrium)
- NEP-MAC-2007-08-14 (Macroeconomics)
- NEP-MON-2007-08-14 (Monetary Economics)
- NEP-UPT-2007-08-14 (Utility Models & Prospect Theory)
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