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The Role of Bounded Rationality in Macro-Finance Affine Term-Structure Models

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  • Yun, Tack
  • Kim, Jinsook
  • Ko, Eunmi

Abstract

Our goal in this paper is two-fold. First, we develop a class of term structure models that allow for the role of bounded rationality by incorporating either information-processing constraint or fear for mis-specification into affine term structure models. We indentify a set of sufficient conditions to generate the observational equivalence between affine term-structure models with rational inattention and a fear for model misspecification. The presence of bounded rationality creates a new additional factor that is not spanned by conventional factors such as level, slope, and curvature factors. Second, our empirical results indicate that substantial amounts of information capacity constraint and robustness preference for model misspecification are needed to explain the observed behavior of yields.

Suggested Citation

  • Yun, Tack & Kim, Jinsook & Ko, Eunmi, 2012. "The Role of Bounded Rationality in Macro-Finance Affine Term-Structure Models," MPRA Paper 44212, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:44212
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    References listed on IDEAS

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    1. Scott Joslin & Kenneth J. Singleton & Haoxiang Zhu, 2011. "A New Perspective on Gaussian Dynamic Term Structure Models," The Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 926-970.
    2. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, vol. 95(1), pages 138-160, March.
    3. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
    4. Michael D. Bauer & Glenn D. Rudebusch & Jing Cynthia Wu, 2011. "Unbiased estimate of dynamic term structure models," Working Paper Series 2011-12, Federal Reserve Bank of San Francisco.
    5. Yulei Luo & Eric R. Young, 2014. "Signal Extraction And Rational Inattention," Economic Inquiry, Western Economic Association International, vol. 52(2), pages 811-829, April.
    6. Hamilton, James D. & Wu, Jing Cynthia, 2014. "Testable implications of affine term structure models," Journal of Econometrics, Elsevier, vol. 178(P2), pages 231-242.
    7. Gregory R. Duffee, 2011. "Information in (and not in) the Term Structure," The Review of Financial Studies, Society for Financial Studies, vol. 24(9), pages 2895-2934.
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    Cited by:

    1. Luo, Yulei & Young, Eric, 2013. "Rational Inattention in Macroeconomics: A Survey," MPRA Paper 54267, University Library of Munich, Germany.

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    More about this item

    Keywords

    Rational Inattention; Robustness; Affine Term Structure Models; No-Arbitrage;
    All these keywords.

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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