The Term Structure of Interest Rates: Bounded or Falling?

David Feldman

Review of Finance, 2003, vol. 7, issue 1, 103-113

Abstract: This short paper resolves an apparent contradiction between Feldman's (1989) and Riedel's (2000) equilibrium models of the term structure of interest rates under incomplete information. Feldman (1989) showed that in an incomplete information version of Cox, Ingersoll, and Ross (1985), where the stochastic productivity factors are unobservable, equilibrium term structures are ‘interior’ and bounded. Interestingly, Riedel (2000) showed that an incomplete information version of Lucas (1978), with an unobservable constant growth rate, induces a ‘corner’ unbounded equilibrium term structure: it decreases to negative infinity. This paper defines constant and stochastic asymptotic moments, clarifies the apparent conflict between Feldman's and Riedel's equilibria, and discusses implications. Because productivity and growth rates are not directly observable in the real world, the question we answer is of particular relevance. JEL Classification codes: E43, G12, D92, D80, D51.

Date: 2003
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