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Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?

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  • ANTONIOS SANGVINATSOS
  • JESSICA A. WACHTER

Abstract

We solve the portfolio problem of a long-run investor when the term structure is Gaussian and when the investor has access to nominal bonds and stock. We apply our method to a three-factor model that captures the failure of the expectations hypothesis. We extend this model to account for time-varying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio of a long-run investor looks very different from the portfolio of a mean-variance optimizer. In particular, time-varying term premia generate large hedging demands for long-term bonds. Copyright 2005 by The American Finance Association.

Suggested Citation

  • Antonios Sangvinatsos & Jessica A. Wachter, 2005. "Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?," Journal of Finance, American Finance Association, vol. 60(1), pages 179-230, February.
  • Handle: RePEc:bla:jfinan:v:60:y:2005:i:1:p:179-230
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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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