The Term Structure of Interest Rates in an Equilibrium Economy with Short Term and Long Term Investments

52 Pages Posted: 19 Feb 2009

See all articles by Carles Vergara-Alert

Carles Vergara-Alert

University of Navarra - IESE Business School

Multiple version iconThere are 3 versions of this paper

Date Written: February 15, 2009

Abstract

This paper develops an equilibrium model in which agents' heterogeneous investment horizons determine the dynamics of the real term structure of interest rates. The model endogenizes agents' decisions on consumption and investments with short and long term horizons. There are two production technologies that generate a time-varying market price of risk: one that is short term and fully reversible, and one that is equivalent to a long term time-to-build technology. The paper shows that the ratio of long to short term capital invested in these technologies is a key factor that influences the term structure and provides speci c formulas for the equilibrium real short interest rate, bond prices, and consumption dynamics that are functions of this ratio. The model is calibrated with U.S. data from 1970 to 2007 using Simulated Method of Moments and captures realistic means and volatilities of consumption, investments and real short term, and long term interest rates.

Keywords: Term Structure, Yield Curve, Interest Rates, General Equilibrium, Consumption, Investments, Time-to-build, Simulated Method of Moments

JEL Classification: G00, C61, G12, C68, G10

Suggested Citation

Vergara-Alert, Carles, The Term Structure of Interest Rates in an Equilibrium Economy with Short Term and Long Term Investments (February 15, 2009). EFA 2009 Bergen Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1343970 or http://dx.doi.org/10.2139/ssrn.1343970

Carles Vergara-Alert (Contact Author)

University of Navarra - IESE Business School ( email )

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HOME PAGE: http://web.iese.edu/cvergara/

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