Long Term Bond Markets and Investor Welfare
University of Pennsylvania Finance Working Paper
45 Pages Posted: 24 May 2001
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: Suggested Citation
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