The Real Term Premium in a Stationary Economy with Segmented Asset Markets

YiLi Chien and Junsang Lee

No 2018-30, Working Papers from Federal Reserve Bank of St. Louis

Abstract: This paper proposes an equilibrium model to explain the positive and sizable term premia observed in the data. We introduce a slow mean-reverting process of consumption growth and a segmented asset market mechanism with heterogeneous trading technology to otherwise a standard heterogeneous agent general equilibrium model. First, a slow mean-reverting consumption growth process implies that the expected consumption growth rate is only slightly countercyclical and the process can exhibit a near zero first-order autocorrelation as seen in the data. The very small countercyclicality of the expected consumption growth rate suggests that the long term bonds are risky and hence the term premia are positive. Second, the segmented asset market mechanism amplifies the size and the magnitude of term premia since the aggregate risk is concentrated into a small fraction of marginal traders who demand high risk premia. For sensitivity analysis, the role of each assumption is further investigated by taking each factor out one by one.

Keywords: Limited Participation; Term Premia; Portfolio Heterogeneity; Household Finance (search for similar items in EconPapers)
JEL-codes: E30 G11 G12 (search for similar items in EconPapers)
Date: 2018-04-03
New Economics Papers: this item is included in nep-dge, nep-mac and nep-ore
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Journal Article: The Real Term Premium in a Stationary Economy with Segmented Asset Markets (2019)
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DOI: 10.20955/wp.2018.030

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