Ambiguity Aversion, Bond Pricing and the Non-Robustness of Some Affine Term Structures
56 Pages Posted: 1 Mar 2005
Date Written: February 2005
We develop a continuous time general equilibrium yield curve model under ambiguity aversion. Even a moderate level of 'aggregate ambiguity' affects significantly the term structure and can drive the prices of common interest rate derivatives toward the patterns observed in fixed income markets. Equilibrium term premia and interest rates have rich functional forms, with random factors unpriced under the 'standard' paradigm that pay a premium for ambiguity.
Explicit descriptions of the impact of ambiguity aversion on popular term structure factor models are provided both for cases where ambiguity is time varying and for cases where it is not.
Keywords: General equilibrium, ambiguity, term structure, interest rate derivatives
JEL Classification: D58, D81, E43, G12, G13
Suggested Citation: Suggested Citation