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A Consumption-Based Model of the Term Structure of Interest Rates (2004)
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BibTeX
@MISC{Wachter04aconsumption-based,
author = {Jessica A. Wachter},
title = { A Consumption-Based Model of the Term Structure of Interest Rates },
year = {2004}
}
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Abstract
This paper proposes a consumption-based model that can account for many features of the nominal term structure of interest rates. The driving force behind the model is a time-varying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expected inflation. When calibrated to data on consumption, inflation, and the average level of bond yields, the model produces realistic volatility of bond yields and can explain key aspects of the expectations puzzle documented by Campbell and Shiller (1991) and Fama and Bliss (1987). When actual consumption and inflation data are fed into the model, the model is shown to account for many of the short and long-run fluctuations in the short-term interest rate and the yield spread. At the same time, the model captures the high equity premium and
Keyphrases
interest rate consumption-based model term structure bond yield yield spread high equity premium many feature past consumption growth long-run fluctuation realistic volatility key aspect actual consumption inflation data external habit average level nominal bond driving force nominal term structure time-varying price short-term interest rate
