Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?
62 Pages Posted: 3 Nov 2008
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Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?
Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?
Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?
Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?
Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?
Date Written: January 2003
Abstract
We consider the consumption and portfolio choice problem of a long-run investor when the term structure is affine and when the investor has access to nominal bonds and a stock portfolio. In the presence of unhedgeable inflation risk, there exist multiple pricing kernels that produce the same bond prices, but a unique pricing kernel equal to the marginal utility of the investor. We apply our method to a three-factor Gaussian model with a time-varying price of risk that captures the failure of the expectations hypothesis seen in the data. We extend this model to account for time-varying expected inflation, andestimate the model with both inflation and term structure data. The estimates simply that the bond portfolio for the long-run investor looks very different fromthe portfolio of a mean-variance optimizer. In particular, the desire to hedgechanges in term premia generates large hedging demands for long-term bonds
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