The Bond Premium in a DSGE Model with Long-Run Real and Nominal Risks
National Bank of Belgium Working Paper No. 143
50 Pages Posted: 2 Oct 2010
There are 2 versions of this paper
The Bond Premium in a DSGE Model with Long-Run Real and Nominal Risks
Date Written: October 16, 2008
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 face long-run economic risks and have recursive Epstein-Zin preferences. We show that introducing these two elements 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.
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