Ambiguity Aversion and the Term Structure of Interest Rates
Series
VWA Discussion Papers
Type
discussion paper
Date Issued
2007-07-31
Author(s)
Gagliardini, Patrick
;
Porchia, Paolo
;
Trojani, Fabio
Abstract
This paper studies the term structure implications of a simple structural economy in which the representative agent displays ambiguity aversion, modeled by Multiple Priors Recursive Utility. Bond excess returns reflect a premium for ambiguity, which is observationally distinct from the risk premium of affine yield curve models. The ambiguity premium can be large even in the simplest logutility model and is non zero also for stochastic factors that have a zero risk premium. A calibrated low-dimensional two-factor economy with ambiguity is able to reproduce the deviations from the expectations hypothesis documented in the literature, without modifying in a substantial way the nonlinear mean reversion dynamics of the short interest rate. In this economy, we do not find any apparent tradeoffs between fitting the first and second moments of the yield curve and the large equity premium.
Language
English
Keywords
General Equilibrium
Term Structure of Interest Rates
Ambiguity Aversion
Expectations Hypothesis
Campbell-Shiller Regression
HSG Classification
contribution to scientific community
Refereed
No
Publisher place
St.Gallen
Number
2007-29
Start page
45
Subject(s)
Division(s)
Eprints ID
38670
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Name
DP-29-Ga.pdf
Size
873.31 KB
Format
Adobe PDF
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