The Long-Term Discount Rate

34 Pages Posted: 19 Feb 2009 Last revised: 14 Jul 2009

See all articles by Christine A. Parlour

Christine A. Parlour

University of California, Berkeley - Finance Group

Richard Stanton

University of California, Berkeley - Haas School of Business

Johan Walden

University of California, Berkeley - Finance Group

Date Written: June 2009

Abstract

We study the term structure of interest rates in a two-tree exchange economy. Even when one of the trees is very small, interest rates are determined differently than in a single tree economy. Rather than always being flat, the yield curve is usually upward sloping but may be downward sloping. In the latter case, the slope predicts a future increase in consumption growth rates and lower future short-term interest rates. In addition, the short and the long interest rates are driven by different variables. As in the one-tree model, the short rate depends on risk aversion; however the long rate depends on consumption growth and volatility, but \emph{not} on the representative investor's risk aversion. Therefore, our results provide a resolution of the risk-free rate puzzle, and demonstrate the fragility of the one-tree model.

Keywords: Term structure, yield curve, risk-free rate puzzle, two trees, Lucas model, asset pricing

JEL Classification: E43, G12

Suggested Citation

Parlour, Christine A. and Stanton, Richard H. and Walden, Johan, The Long-Term Discount Rate (June 2009). EFA 2009 Bergen Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1344797 or http://dx.doi.org/10.2139/ssrn.1344797

Christine A. Parlour

University of California, Berkeley - Finance Group ( email )

Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States
510-643-9391 (Phone)

Richard H. Stanton

University of California, Berkeley - Haas School of Business ( email )

Haas School of Business
545 Student Services Building #1900
Berkeley, CA 94720-1900
United States
(510) 642-7382 (Phone)
(510) 643-1412 (Fax)

Johan Walden (Contact Author)

University of California, Berkeley - Finance Group ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
(510) 643-0547 (Phone)

HOME PAGE: http://www.haas.berkeley.edu/faculty/walden.html

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