Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors

Antonios Sangvinatsos and Jessica A. Wachter ()

No 10086, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We consider the consumption and portfolio choice problem of a long-run investor when the term structure is affine and when the investor has access to nominal bonds and a stock portfolio. In the presence of unhedgeable inflation risk, there exist multiple pricing kernels that produce the same bond prices, but a unique pricing kernel equal to the marginal utility of the investor. We apply our method to a three-factor Gaussian model with a time-varying price of risk that captures the failure of the expectations hypothesis seen in the data. We extend this model to account for time-varying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio for the long-run investor looks very different from the portfolio of a mean-variance optimizer. In particular, the desire to hedge changes in term premia generates large hedging demands for long-term bonds.

JEL-codes: G1 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn and nep-mac
Date: 2003-11
Note: AP
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Journal Article: Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors? (2005)
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