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Rare Disasters and the Term Structure of Interest Rates

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  • Jerry Tsai

Abstract

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.

Suggested Citation

  • Jerry Tsai, 2013. "Rare Disasters and the Term Structure of Interest Rates," Economics Series Working Papers 665, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:665
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    References listed on IDEAS

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    Cited by:

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    3. Favero, Carlo A. & Tamoni, Andrea & Ortu, Fulvio & Yang, Haoxi, 2016. "Implications of Return Predictability across Horizons for Asset Pricing Models," CEPR Discussion Papers 11645, C.E.P.R. Discussion Papers.
    4. Irina Zviadadze, 2021. "Term Structure of Risk in Expected Returns [Stock returns and volatility: Pricing the short-run and long-run components of market risk]," The Review of Financial Studies, Society for Financial Studies, vol. 34(12), pages 6032-6086.

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    More about this item

    Keywords

    Term structure of interest rates; rare disasters;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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