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Risk Aversion, Intertemporal Substitution, and the Term Structure of Interest Rates

  • René Garcia
  • Richard Luger

We build and estimate an equilibrium model of the term structure of interest rates based on a recursive utility specification. We contrast it with an arbitrage-free model, where prices of risk are estimated freely without preference constraints. In both models, nominal bond yields are affine functions of macroeconomic state variables. The equilibrium model accounts for the tent-shaped pattern and magnitude of coefficients from predictive regressions of excess bond returns on forward rates and the hump-shaped pattern in the term structure of volatilities, while the reduced-form no-arbitrage model does not account for these important features of the yield curve. Nous construisons et évaluons un modèle d'équilibre de la structure par terme des taux d'intérêt, fondé sur une caractéristique de la fonction d'utilité récursive. Nous le comparons à un modèle caractérisé par l'absence d'arbitrage, dans lequel les prix du risque sont estimés librement sans contrainte de préférence. Dans les deux modèles, les rendements des obligations nominales sont des fonctions affines des variables d'état macroéconomique. Le modèle d'équilibre prend en compte le profil en forme de tente (tent-shaped) et l'ampleur des coefficients de régression prédictive relatifs aux rendements des obligations excédant les taux d'intérêt à terme, de même que le profil en forme de bosse (hump-shaped) dans la structure par terme des volatilités, tandis que le modèle à forme réduite et caractérisé par l'absence d'arbitrage ne tient pas compte de ces caractéristiques importantes de la courbe de rendement.

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Paper provided by CIRANO in its series CIRANO Working Papers with number 2009s-20.

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Length: 54 pages
Date of creation: 01 May 2009
Date of revision:
Handle: RePEc:cir:cirwor:2009s-20
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