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Heterogeneous time preferences and interest rates—the preferred habitat theory revisited

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  • Frank Riedel

Abstract

The influence of heterogeneous time preferences on the term structure is studied in the framework of a continuous-time pure exchange economy, in which agents have, apart from differential time preferences, the same degree of relative risk aversion. A closed-form solution for the financial equilibrium is obtained. In equilibrium, one long-term bond and one short-term bond form a complete market. Agents use these bonds to finance their consumption plans. The long-term bond is bought by agents with a long habitat. The short rate is a weighted average of the short rates which prevail in homogeneous economies populated by one type of agent only. It is shown by example that heterogeneity of time preferences can produce additional humps in the yield curve.

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  • Frank Riedel, 2004. "Heterogeneous time preferences and interest rates—the preferred habitat theory revisited," The European Journal of Finance, Taylor & Francis Journals, vol. 10(1), pages 3-22.
    • Handle: RePEc:taf:eurjfi:v:10:y:2004:i:1:p:3-22
    DOI: 10.1080/13518470210160885
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    Cited by:

    1. David Feldman, 2007. "Incomplete information equilibria: Separation theorems and other myths," Annals of Operations Research, Springer, vol. 151(1), pages 119-149, April.

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    More about this item

    Keywords

    time preferences; term structure; interest rates; Preferred Habitat Theory; heterogeneity;
    All these keywords.

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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