Ambiguity Aversion and the Term Structure of Interest Rates
University of St. Gallen, Department of Economics, Discussion Paper No. 2007-29
48 Pages Posted: 9 Aug 2007 Last revised: 5 Aug 2008
There are 2 versions of this paper
Ambiguity Aversion and the Term Structure of Interest Rates
Ambiguity Aversion and the Term Structure of Interest Rates
Date Written: July 2007
Abstract
This paper studies the term structure implications of a simple structural economy in which the representative agent displays ambiguity aversion, modeled by Multiple Priors Recursive Utility. Bond excess returns reflect a premium for ambiguity, which is observationally distinct from the risk premium of affine yield curve models. The ambiguity premium can be large even in the simplest logutility model and is non zero also for stochastic factors that have a zero risk premium. A calibrated low-dimensional two-factor economy with ambiguity is able to reproduce the deviations from the expectations hypothesis documented in the literature, without modifying in a substantial way the nonlinear mean reversion dynamics of the short interest rate. In this economy, we do not find any apparent tradeoffs between fitting the first and second moments of the yield curve and the large equity premium.
Keywords: General Equilibrium, Term Structure of Interest Rates, Ambiguity Aversion, Expectations Hypothesis, Campbell-Shiller Regression
JEL Classification: C68, G12, G13
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
A Smooth Model of Decision Making Under Ambiguity
By Peter Klibanoff, Massimo Marinacci, ...
-
Model Misspecification and Under-Diversification
By Tan Wang and Raman Uppal
-
Model Misspecification and Under-Diversification
By Tan Wang and Raman Uppal
-
By Larry G. Epstein and Martin Schneider
-
Model Uncertainty, Limited Market Participation and Asset Prices
By H. Henry Cao, Harold H. Zhang, ...
-
Ambiguity, Learning, and Asset Returns
By Nengjiu Ju and Jianjun Miao
-
Learning and Asset Prices Under Ambiguous Information
By Paolo Vanini, Markus Leippold, ...
-
By David Easley and Maureen O'hara
-
By Larry G. Epstein and Martin Schneider