The Consumption-Based Determinants of the Term Structure of Discount Rates

37 Pages Posted: 13 Jan 2005

See all articles by Christian Gollier

Christian Gollier

University of Toulouse 1 - Industrial Economic Institute (IDEI); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: January 2005

Abstract

The efficient rate of return of a zero-coupon bond with maturity t is determined by our expectations about the mean (+), variance (-) and skewness (+) of the growth of aggregate consumption between 0 and t. The shape of the yield curve is thus determined by how these moments vary with t. We first examine growth processes in which a higher past economic growth yields a first-degree dominant shift in the distribution of the future economic growth, as assumed for example by Vasicek (1977). We show that when the growth process exhibits such a positive serial correlation, then the yield curve is decreasing if the representative agent is prudent (u ' > 0), because of the increased risk that it yields for the distant future. A similar definition is proposed for the concept of second-degree stochastic correlation, as observed for example in the Cox-Ingersoll-Ross model, with the opposite comparative static property holding under temperance (u ' < 0), because the change in downside risk (or skweness) that it generates. Finally, using these theoretical results, we propose two arguments in favor of using a smaller rate to discount cash-flows with very long maturities, such as those associated to global warming or nuclear waste management.

Keywords: stochastic dominance, yield curve, far distant future, cost-benefit analysis, prudence, temperance, downside risk

JEL Classification: G12, E43, Q51

Suggested Citation

Gollier, Christian, The Consumption-Based Determinants of the Term Structure of Discount Rates (January 2005). CESifo Working Paper Series No. 1375. Available at SSRN: https://ssrn.com/abstract=648101

Christian Gollier (Contact Author)

University of Toulouse 1 - Industrial Economic Institute (IDEI) ( email )

Manufacture des Tabacs
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Toulouse Cedex, F-31000
France
+33 61 12 86 30 (Phone)
+33 61 12 86 37 (Fax)

CESifo (Center for Economic Studies and Ifo Institute) ( email )

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Munich, DE-81679
Germany

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