Limited Household Risk Sharing: General Equilibrium Implications for the Term Structure of Interest Rates

Indrajit Mitra and Yu Xu

No 2020-20, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

Abstract: We present a theory in which limited risk sharing of idiosyncratic labor income risk plays a key role in determining the dynamics of interest rates. Our production-based model relates the cross-sectional distribution of labor income risk to observable aggregate labor market variables. Our model makes two key predictions. First, it predicts positive risk premia for long-term bonds while simultaneously matching key macroeconomic moments. Second, it predicts a negative correlation between current labor market conditions (as measured by labor market tightness or the job-finding rate) and future bond excess returns. We provide evidence for these predictions.

Keywords: interest rates; nondiversifiable labor income risk; labor market frictions; bond risk premia (search for similar items in EconPapers)
JEL-codes: A12 E24 E43 E44 G12 J64 (search for similar items in EconPapers)
Pages: 50
Date: 2020-11-09
New Economics Papers: this item is included in nep-dge and nep-mac
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Published in 2020

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedawp:89452

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DOI: 10.29338/wp2020-20

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