Robust Equilibrium Yield Curves

Isaac Kleshchelski and Nicolas Vincent

Cahiers de recherche from CIRPEE

Abstract: This paper studies the quantitative implications of the interaction between robust control and stochastic volatility for key asset pricing phenomena. We present an equilibrium term structure model in which output growth is conditionally heteroskedastic. The agent does not know the true model of the economy and chooses optimal policies that are robust to model misspecification. The choice of robust policies greatly amplifies the effect of conditional heteroskedasticity in consumption growth, improving the model's ability to explain asset prices. In a robust control framework, stochastic volatility in consumption growth generates both a state-dependent market price of model uncertainty and a stochastic market price of risk. We estimate the model using data from the bond and equity market, as well as consumtion data. We show that the model is consistent with key empirical regularities that characterize the bond and equity markets. We also characterize empirically the set of models the robust representative agent entertains, and show that this set is "small". In other words, it is statistically difficult to distinguish between models in this set.

Keywords: Yield curve; market price of uncertainty; robust control (search for similar items in EconPapers)
JEL-codes: D81 E43 G11 G12 (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-dge and nep-fmk
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Citations: View citations in EconPapers (4)

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Related works:
Working Paper: Robust Equilibrium Yield Curves (2008)
Working Paper: Robust Equilibrium Yield Curves (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:lvl:lacicr:0907

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