The Bond Premium in a DSGE Model with Long-Run Real and Nominal Risks

45 Pages Posted: 22 Mar 2009

See all articles by Glenn D. Rudebusch

Glenn D. Rudebusch

Federal Reserve Bank of San Francisco

Eric T. Swanson

University of California, Irvine - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: January 30, 2009

Abstract

The term premium on nominal long-term bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data - an example of the bond premium puzzle. However, in models of endowment economies, researchers have been able to generate reasonable term premiums by assuming that investors have recursive Epstein-Zin preferences and face long-run economic risks. We show that introducing Epstein-Zin preferences into a canonical DSGE model can also produce a large and variable term premium without compromising the model's ability to fit key macroeconomic variables. Long-run real and nominal risks further improve the model's ability to fit the data with a lower level of household risk aversion.

Keywords: yield curve, term premium, bond pricing, long-run risk

JEL Classification: G12, E43

Suggested Citation

Rudebusch, Glenn D. and Swanson, Eric T., The Bond Premium in a DSGE Model with Long-Run Real and Nominal Risks (January 30, 2009). Available at SSRN: https://ssrn.com/abstract=1364348 or http://dx.doi.org/10.2139/ssrn.1364348

Glenn D. Rudebusch

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

Eric T. Swanson (Contact Author)

University of California, Irvine - Department of Economics ( email )

University of California, Irvine
3151 Social Science Plaza
Irvine, CA 92697-5100
United States
(949) 824-8305 (Phone)

HOME PAGE: http://www.ericswanson.org

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