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Disappointment Aversion, Term Structure, and Predictability Puzzles in Bond Markets

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  • Patrick Augustin

    (Desautels Faculty of Management and Canadian Derivatives Institute, McGill University, Montréal, Québec H3A 1G5, Canada)

  • Roméo Tédongap

    (ESSEC Business School Paris–Singapore, 95021 Cergy-Pontoise, France)

Abstract

We solve a dynamic equilibrium model with generalized disappointment-aversion preferences and continuous state-endowment dynamics. We apply the framework to the term structure of interest rates and show that the model generates an upward-sloping term structure of nominal interest rates and a downward-sloping term structure of real interest rates and that it accounts for the failure of the expectations hypothesis. The key ingredients are preferences with disappointment aversion, preference for early resolution of uncertainty, and an endowment economy with three state variables: time-varying macroeconomic uncertainty, time-varying expected inflation, and inflation uncertainty.

Suggested Citation

  • Patrick Augustin & Roméo Tédongap, 2021. "Disappointment Aversion, Term Structure, and Predictability Puzzles in Bond Markets," Management Science, INFORMS, vol. 67(10), pages 6266-6293, October.
    • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:10:p:6266-6293
    DOI: 10.1287/mnsc.2020.3757
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    Cited by:

    1. Zongxia Liang & Sheng Wang & Jianming Xia & Fengyi Yuan, 2024. "Dynamic portfolio selection under generalized disappointment aversion," Papers 2401.08323, arXiv.org, revised Mar 2024.

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