Testing the preferred-habitat theory: The role of time-varying risk aversion

Till Strohsal

No 2013-043, SFB 649 Discussion Papers from Humboldt University Berlin, Collaborative Research Center 649: Economic Risk

Abstract: This paper examines the preferred-habitat theory under time-varying risk aversion. The predicted positive relation between the term spread and relative supply of longer-term debt is stronger when risk aversion is high. To capture this effect, a time-varying coefficient model is introduced and applied to German bond data. The results support the theoretical predictions and indicate substantial time variation: under high risk aversion, yield spreads react about three times more strongly than when risk aversion is low. The accumulated response of term spreads to a one standard deviation change in debt supply ranges between 5 and 33 basis points.

Keywords: preferred-habitat; time-varying risk aversion; yield spreads; bond supply (search for similar items in EconPapers)
JEL-codes: C22 E43 (search for similar items in EconPapers)
Date: 2013
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:sfb649:sfb649dp2013-043

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