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The bond premium in a DSGE model with long-run real and nominal risks

  • Glenn D. Rudebusch

    ()

    (Federal Reserve Bank of San Francisco)

  • Eric T. Swanson

    ()

    (Federal Reserve Bank of San Francisco)

The term premium on nominal long-term bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data - an example of the "bond premium puzzle." However, in models of endowment economies, researchers have been able to generate reasonable term premiums by assuming that investors face long-run economic risks and have recursive Epstein-Zin preferences. We show that introducing these two elements into a canonical DSGE model can also produce a large and variable term premium without compromising the model's ability to fit key macroeconomic variables.

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Paper provided by National Bank of Belgium in its series Working Paper Research with number 143.

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Length: 50 pages
Date of creation: Oct 2008
Date of revision:
Handle: RePEc:nbb:reswpp:200810-18
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