The Term Structure of Interest Rate in an Economy Where Investors Have Heterogeneous Recursive Preferences
The Quarterly Review of Economics and Finance, Vol. 48, pp. 457-481, 2008
33 Pages Posted: 4 Apr 2006 Last revised: 18 Nov 2010
Date Written: March 1, 2004
This paper presents an equilibrium model of the term structure of interest rates when investors have heterogeneous recursive preferences. We consider a pure exchange economy with two classes of investors who have different relative risk aversions and different elasticities of intertemporal substitution. The RRA and the EIS can be varied independently for each investor. We use the model to examine the effects that the heterogeneity in preferences of investors has on their portfolio-consumption choices as well as on the instantaneous interest rate and bond yield. We find that the heterogeneity only in the RRA affects the cross-sectional as well as intertemporal variations of the consumption rate, the portfolio allocations for each investor and the instantaneous interest rate. However, the heterogeneity only in the EIS matters only for the intertemporal variations of these processes.
Keywords: Equilibrium, Recursive Utility, Asset Pricing, Term Structure
JEL Classification: D4, D5, C0, D8
Suggested Citation: Suggested Citation