Habit Persistence and the Nominal Term Premium Puzzle: A Partial Resolution

Kevin Salyer ()

Economic Inquiry, 1995, vol. 33, issue 4, 672-91

Abstract: The assumption of habit formation in preferences induces two effects on time series of agents' marginal utility of consumption: greater volatility relative to standard time-separable preferences and negative serial correlation. This paper examines whether the second property can help explain the behavior of the nominal term premium. A cash-in-advance model of interest rates is appended with a model of habit persistence and calibrated to U.S. data. Using yields on three- and six-month U.S. Treasury Bills for comparison, the author finds the model can indeed duplicate the observed average term premium but cannot account for the term premium's volatility. Copyright 1995 by Oxford University Press.

Date: 1995
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Working Paper: Habit Persistence and the Nominal Term Premium Puzzle: A Partial Resolution (1993)
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