Bond Risk Premia in Consumption-Based Models

59 Pages Posted: 25 Apr 2016 Last revised: 11 Feb 2023

See all articles by Drew Creal

Drew Creal

University of Chicago - Booth School of Business - Econometrics and Statistics

Jing Cynthia Wu

University of Notre Dame - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: April 2016

Abstract

Workhorse Gaussian affine term structure models (ATSMs) attribute time-varying bond risk premia entirely to changing prices of risk, while structural models with recursive preferences credit it completely to stochastic volatility. We reconcile these competing channels by introducing a novel form of external habit into an otherwise standard model with recursive preferences. The new model has an ATSM representation with analytical bond prices making it empirically tractable. We find that time variation in bond term premia is predominantly driven by the price of risk, especially, the price of expected inflation risk that co-moves with expected inflation itself.

Suggested Citation

Creal, Drew and Wu, Jing Cynthia, Bond Risk Premia in Consumption-Based Models (April 2016). NBER Working Paper No. w22183, Available at SSRN: https://ssrn.com/abstract=2769715

Drew Creal (Contact Author)

University of Chicago - Booth School of Business - Econometrics and Statistics ( email )

Chicago, IL 60637
United States

Jing Cynthia Wu

University of Notre Dame - Department of Economics ( email )

Notre Dame, IN 46556
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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