Model Uncertainty and Term Structure Anomalies

50 Pages Posted: 12 Mar 2015 Last revised: 19 Nov 2015

See all articles by Ting Wu

Ting Wu

Shanghai University of Finance and Economics

Xiaoneng Zhu

Shanghai University of Finance and Economics

Date Written: October 7, 2015

Abstract

We construct an equilibrium term structure model that is robust to economic agent's uncertainty about the true data generating process. The low-dimensional two-factor long-run risk model captures the intuition that an ambiguity averse agent behaves pessimistically by attaching more weight to the data generating process implying a lower lifetime utility. Our calibrated model can largely match the mean interest rates and the volatility of interest rates. Importantly, the model can help resolve several challenges to standard representative-agent models such as the excess volatility puzzle, the empirical failure of the expectations hypothesis, the positive yield spread, and the predictability of bond risk premia.

Keywords: Ambiguity, bond risk premia, model uncertainty, term structure, robustness.

JEL Classification: E31, E4, G12;

Suggested Citation

Wu, Ting and Zhu, Xiaoneng, Model Uncertainty and Term Structure Anomalies (October 7, 2015). Available at SSRN: https://ssrn.com/abstract=2576554 or http://dx.doi.org/10.2139/ssrn.2576554

Ting Wu

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

Xiaoneng Zhu (Contact Author)

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

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