Disappointment Aversion, Term Structure, and Predictability Puzzles in Bond Markets

41 Pages Posted: 29 Aug 2014 Last revised: 18 May 2016

See all articles by Patrick Augustin

Patrick Augustin

McGill University, Desautels Faculty of Management

Roméo Tédongap

ESSEC Business School

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2014

Abstract

We solve a dynamic general equilibrium model with generalized disappointment aversion preferences and continuous state endowment dynamics. We apply the framework to the term structure of interest rates and show that the model generates an upward sloping term structure of nominal interest rates, a downward sloping term structure of real interest rates, and that it accounts for the failure of the expectations hypothesis. The key ingredients are disappointment aversion preferences, preference for early resolution of uncertainty, and a parsimonious endowment economy with three state variables: time-varying macroeconomic uncertainty, time-varying expected inflation and inflation uncertainty.

Keywords: Generalized Disappointment Aversion, Expectations Hypothesis, Numerical Solution Methods, Term Structure of Interest Rates

JEL Classification: C61, C63, E43, E44, G11, G12, G13

Suggested Citation

Augustin, Patrick and Tédongap, Roméo, Disappointment Aversion, Term Structure, and Predictability Puzzles in Bond Markets (September 1, 2014). Swedish House of Finance Research Paper No. 14-14, Available at SSRN: https://ssrn.com/abstract=2488517 or http://dx.doi.org/10.2139/ssrn.2488517

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Roméo Tédongap

ESSEC Business School ( email )

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