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Habit Formation and Macroeconomic Models of the Term Structure of Interest Rates

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  • ANDREA BURASCHI
  • ALEXEI JILTSOV

Abstract

This paper introduces a new class of nonaffine models of the term structure of interest rates that is supported by an economy with habit formation. Distinguishing features of the model are that the interest rate dynamics are nonlinear, interest rates depend on lagged monetary and consumption shocks, and the price of risk is not a constant multiple of interest rate volatility. We find that habit persistence can help reproduce the nonlinearity of the spot rate process, the documented deviations from the expectations hypothesis, the persistence of the conditional volatility of interest rates, and the lead‐lag relationship between interest rates and monetary aggregates.

Suggested Citation

  • Andrea Buraschi & Alexei Jiltsov, 2007. "Habit Formation and Macroeconomic Models of the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 62(6), pages 3009-3063, December.
    • Handle: RePEc:bla:jfinan:v:62:y:2007:i:6:p:3009-3063
    DOI: 10.1111/j.1540-6261.2007.01299.x
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