Long Term Bond Markets and Investor Welfare

University of Pennsylvania Finance Working Paper

45 Pages Posted: 24 May 2001

See all articles by Yihong Xia

Yihong Xia

University of California, Los Angeles (Deceased)

Date Written: May 23, 2001

Abstract

A simple framework is developed to analyze the important role of the bond market for the welfare of a long horizon small investor when both inflation and the real interest rate are stochastic. Closed form solutions for investor utility in different settings are used to show that the welfare loss due to the absence of long term bond markets increases with the investor's horizon and risk aversion, and with the size and persistence of the shocks to the real interest rate, but decreases with the correlation between the stock return and real interest rate. Using parameter estimates derived from U.S. data, we show that the welfare costs of the lack of a bond market can be substantial.

Keywords: Long term nominal bonds, long horizon investor portfolio choice, certainty equivalent wealth

JEL Classification: G100, G110, G120

Suggested Citation

Xia, Yihong, Long Term Bond Markets and Investor Welfare (May 23, 2001). University of Pennsylvania Finance Working Paper, Available at SSRN: https://ssrn.com/abstract=271089 or http://dx.doi.org/10.2139/ssrn.271089

Yihong Xia (Contact Author)

University of California, Los Angeles (Deceased)