Present Bias, Asset Allocation and the Yield Curve
50 Pages Posted: 23 Nov 2020 Last revised: 22 Dec 2020
Date Written: September 21, 2020
This paper presents a present-biased general equilibrium model that explains many features of bond behavior. Present-biased investors increase (decrease) short-term (long-term) hedge demands compared to standard preferences. Hence, present bias drives up (down) short-term bond prices (yields) and drives down (up) long-term bond prices (yields), explaining the bond premium puzzle. The model produces realistic bond behavior with a present-bias factor of beta=0.35 and a long-term annual discount factor of delta=0.97, in line with the experimental literature. Bond behavior is best explained for a present-bias interval of at most 1 year, providing an estimate for the investor's duration of the present.
Keywords: hyperbolic discounting, portfolio choice, term structure, duration present, behavioral finance
JEL Classification: G41, G11, G12
Suggested Citation: Suggested Citation