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Equilibrium term structure relations of risky assets in incomplete markets

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  • Eckwert, Bernhard

Abstract

This paper presents a simple theoretical model of the term structure and analyzes the relations among optimal portfolio decisions, the real term structure of asset returns, and the risks and price volatilities of assets with different terms to maturity when the investor preferences are non-time-separable. It is argued that specifying utility to be a non-time-separable function of consumption allows for richer term structure relations than separable specifications. The model is capable to explain why term premiums vary and why the term structure may fail to be monotone. Our analysis also demonstrates that the planning horizon of the agents critically affects the term structure of asset returns. The competitive mechanism tends to undervalue short-term risks relative to long-term risks if the investors have short planning horizons.

Suggested Citation

  • Eckwert, Bernhard, 1993. "Equilibrium term structure relations of risky assets in incomplete markets," Discussion Papers, Series II 214, University of Konstanz, Collaborative Research Centre (SFB) 178 "Internationalization of the Economy".
    • Handle: RePEc:zbw:kondp2:214
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