Consumption volatility risk and the inversion of the yield curve

Adriana Grasso and Filippo Natoli

No 2141, Working Paper Series from European Central Bank

Abstract: We propose a consumption-based model that allows for an inverted term structure of real and nominal risk-free rates. In our framework the agent is subject to time-varying macroeconomic risk and interest rates at all maturities depend on her risk perception which shape saving propensities over time. In bad times, when risk is perceived to be higher in the short- than the long-term, the agent would prefer to hedge against low realizations of consumption in the near future by investing in long-term securities. This determines, in equilibrium, the inversion of the yield curve. Pricing time-varying consumption volatility risk is essential for obtaining the inversion of the real curve and allows to price the average level and slope of the nominal one. JEL Classification: G12

Keywords: habits; inverted yield curve; real rates; uncertainty; volatility risk (search for similar items in EconPapers)
Date: 2018-04
New Economics Papers: this item is included in nep-opm and nep-rmg
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Citations: View citations in EconPapers (1)

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Related works:
Working Paper: Consumption volatility risk and the inversion of the yield curve (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:ecb:ecbwps:20182141

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