Present Bias, Asset Allocation, and Bond Behavior

Abstract

This paper presents a present-biased general equilibrium model that explains multiple features of bond behavior. Present-biased investors increase short-term hedge demands to satisfy short-term needs, compared to standard time-consistent preferences. Hence, a present-biased investor drives down short-term yields and requires a premium on long-term bonds, explaining the upward sloping yield curve. Observed bond behavior is best explained for a short-term orientation of at most 1 year, providing an estimate for the investor's ''duration of the present''.

Keywords: hyperbolic discounting, portfolio choice, term structure of interest rates, duration present, behavioral finance

JEL Classification: E43, G11, G12, G4