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Rare Disasters and the Term Structure of Interest Rates

  • Jerry Tsai

This paper offers an explanation for the properties of the nominal term structure of interest rates and time-varying bond risk premia based on a model with rare consumption disaster risk.� In the model, expected inflation follows a mean reverting process but is also subject to possible large (positive) shocks when consumption disasters occur.� The possibility of jumps in inflation increases nominal yields and the yield spread, while time-variation in the inflation jump probability drives time-varying bond risk premia.� Predictability regressions offer independent evidence for the model's ability to generate realistic implications for both the stock and bond markets.

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File URL: http://www.economics.ox.ac.uk/materials/papers/12778/paper665.pdf
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Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 665.

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Date of creation: 05 Jul 2013
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Handle: RePEc:oxf:wpaper:665
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