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25
"Peso Problem" Explanations for Term Structure Anomalies
, 1997
"... We examine the empirical evidence on the expectations hypothesis of the term structure of interest rates in the United States, the United Kingdom, and Germany using the CampbellShiller (1991) regressions and a vectorautoregressive methodology. We argue that anomalies in the U.S. term structure, do ..."
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Cited by 117 (16 self)
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We examine the empirical evidence on the expectations hypothesis of the term structure of interest rates in the United States, the United Kingdom, and Germany using the CampbellShiller (1991) regressions and a vectorautoregressive methodology. We argue that anomalies in the U.S. term structure, documented by Campbell and Shiller (1991), may be due to a generalized peso problem in which a highinterest rate regime occuued less frequently in the sample of U.S. data than was rationally anticipated. We formalize this idea as a regimeswitching model of shortterm interest rates estimated with data from seven countries. Technically, this model extends recent research on regimeswitching models with statedependent transitions to a crosssectional setting. Use of the small sample distributions generated by the regimeswitching model for inference considerably weakens the evidence against the expectations hypothesis, but it remains somewhat implausible that our datagenerating process produced the U.S. data. However, a model that combines moderate timevariation in term premiums with pesoproblem effects is largely consistent with term structure
Term Structure of Interest Rates with Regime Shifts
 Journal of Finance
, 2002
"... We develop a term structure model where the short interest rate and the market price of risks are subject to discrete regime shifts. Empirical evidence from efficient method of moments estimation provides considerable support for the regime shifts model. Standard models, which include affine specifi ..."
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Cited by 111 (2 self)
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We develop a term structure model where the short interest rate and the market price of risks are subject to discrete regime shifts. Empirical evidence from efficient method of moments estimation provides considerable support for the regime shifts model. Standard models, which include affine specifications with up to three factors, are sharply rejected in the data. Our diagnostics show that only the regime shifts model can account for the welldocumented violations of the expectations hypothesis, the observed conditional volatility, and the conditional correlation across yields. We find that regimes are intimately related to business cycles. MANY PAPERS DOCUMENT THAT THE UNIVARIATE short interest rate process can be reasonably well modeled in the time series as a regime switching process ~see Hamilton ~1988!, Garcia and Perron ~1996!!. In addition to this statistical evidence, there are economic reasons as well to believe that regime shifts are important to understanding the behavior of the entire yield curve. For example, business cycle expansion and contraction “regimes ” potentially
Term structure dynamics in theory and reality
 Review of Financial Studies
, 2003
"... This paper is a critical survey of models designed for pricing fixed income securities and their associated term structures of market yields. Our primary focus is on the interplay between the theoretical specification of dynamic term structure models and their empirical fit to historical changes in ..."
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Cited by 85 (11 self)
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This paper is a critical survey of models designed for pricing fixed income securities and their associated term structures of market yields. Our primary focus is on the interplay between the theoretical specification of dynamic term structure models and their empirical fit to historical changes in the shapes of yield curves. We begin by overviewing the dynamic term structure models that have been fit to treasury or swap yield curves and in which the risk factors follow diffusions, jumpdiffusion, or have “switching regimes. ” Then the goodnessoffits of these models are assessed relative to their abilities to: (i) match linear projections of changes in yields onto the slope of the yield curve; (ii) match the persistence of conditional volatilities, and the shapes of term structures of unconditional volatilities, of yields; and (iii) to reliably price caps, swaptions, and other fixedincome derivatives. For the case of defaultable securities we explore the relative fits to historical yield spreads. 1
Exotic Preferences for Macroeconomists
 In NBER Macroeconomics Annual 2004
, 2005
"... We provide a user’s guide to “exotic ” preferences: nonlinear time aggregators, departures from expected utility, preferences over time with known and unknown probabilities, risksensitive and robust control, “hyperbolic ” discounting, and preferences over sets (“temptations”). We apply each to a num ..."
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Cited by 30 (9 self)
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We provide a user’s guide to “exotic ” preferences: nonlinear time aggregators, departures from expected utility, preferences over time with known and unknown probabilities, risksensitive and robust control, “hyperbolic ” discounting, and preferences over sets (“temptations”). We apply each to a number of classic problems in macroeconomics and finance, including consumption and saving, portfolio choice, asset pricing, and Pareto optimal allocations.
Longrun risk through consumption smoothing
 Review of Financial Studies
, 2010
"... We examine how longrun consumption risk arises endogenously in a standard production economy model where the representative agent has EpsteinZin preferences. Even when technology growth is i.i.d., optimal consumption smoothing induces highly persistent timevariation in expected consumption growt ..."
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Cited by 29 (0 self)
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We examine how longrun consumption risk arises endogenously in a standard production economy model where the representative agent has EpsteinZin preferences. Even when technology growth is i.i.d., optimal consumption smoothing induces highly persistent timevariation in expected consumption growth (longrun risk). This increases the price of risk when investors prefer early resolution of uncertainty, and the model can then account for the low volatility of consumption growth and the high price of risk with a low coe ¢ cient of relative risk aversion. The asset price implications of endogenous longrun risk depends crucially on the persistence of technology shocks and investors preference for the timing of resolution of uncertainty.
Inspecting the Mechanism: Closedform Solutions for Asset Prices
 in Real Business Cycle models”, forthcoming in the Economic Journal
, 2002
"... We derive closedform solutions for asset prices in an RBC economy. The equations are based on a loglinear solution of the RBC model and allow a clearer understanding of the determination of risk premia in models with production. We demonstrate not only why the premium of equity over the riskfree ..."
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Cited by 20 (0 self)
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We derive closedform solutions for asset prices in an RBC economy. The equations are based on a loglinear solution of the RBC model and allow a clearer understanding of the determination of risk premia in models with production. We demonstrate not only why the premium of equity over the riskfree rate is small but also why the premium of equity over a real longterm bond is small and often negative. In particular, risk premia for equity and long real bonds are negative when technology shocks are permanent. Recently, a growing literature has explored the asset pricing implications of real business cycle (RBC) models. Examples are Rouwenhorst (1995), Jermann (1998) and Boldrin et al. (1995). 1 From a methodological point of view, models with production allow a more realistic modelling of consumption and dividends than do the pure exchange economies of Lucas (1978). However, explaining the behaviour of asset prices in production economies is also more challenging. For example, in an exchange economy, an increase in risk premia can be obtained by increasing risk aversion. This is not necessarily true in production economies, since agents can choose a smoother consumption path by substituting between
Sources of entropy in representative agent models
, 2011
"... We propose two performance measures for asset pricing models and apply them to representative agent models with recursive preferences, habits, and jumps. The measures describe the pricing kernel’s dispersion (the entropy of the title) and dynamics (horizon dependence, a measure of how entropy varies ..."
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Cited by 8 (3 self)
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We propose two performance measures for asset pricing models and apply them to representative agent models with recursive preferences, habits, and jumps. The measures describe the pricing kernel’s dispersion (the entropy of the title) and dynamics (horizon dependence, a measure of how entropy varies over different time horizons). We show how each model generates entropy and horizon dependence, and compare their magnitudes to estimates derived from asset returns. This exercise — and transparent loglinear approximations — clarify the mechanisms underlying these models. It also reveals, in some cases, tension between entropy, which should be large enough to account for observed excess returns, and horizon dependence, which should be small enough to account for mean yield spreads.
Understanding In‡ationIndexed Bond Markets: Appendix.”Available online at http://kuznets.fas.harvard.edu/~campbell/papers.html
, 2009
"... SSA, any agency of the Federal Government, or the NBER. We are grateful to Carolin P‡ueger for exceptionally ..."
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Cited by 4 (2 self)
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SSA, any agency of the Federal Government, or the NBER. We are grateful to Carolin P‡ueger for exceptionally
Bond pricing and the macroeconomy
, 2012
"... This chapter reviews some of the academic literature that links nominal and real term structures with the macroeconomy. The main conclusion is that none of our models is consistent with basic properties of nominal yields. It is difficult to explain the average shape of the nominal yield curve, the v ..."
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Cited by 3 (1 self)
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This chapter reviews some of the academic literature that links nominal and real term structures with the macroeconomy. The main conclusion is that none of our models is consistent with basic properties of nominal yields. It is difficult to explain the average shape of the nominal yield curve, the variation of yields over time, and the predictability of excess bond returns. There are two overarching problems. First, much of the variation over time in economic activity is orthogonal to variation in nominal yields, and vice versa. Second, although mean excess returns to nominal Treasury bonds are positive, these returns do not appear to positively covary with risks that require compensation, at least according to standard assetpricing models.