Heterogeneous time preferences and interest rates—the preferred habitat theory revisited

Frank Riedel

The European Journal of Finance, 2004, vol. 10, issue 1, 3-22

Abstract: The influence of heterogeneous time preferences on the term structure is studied in the framework of a continuous-time pure exchange economy, in which agents have, apart from differential time preferences, the same degree of relative risk aversion. A closed-form solution for the financial equilibrium is obtained. In equilibrium, one long-term bond and one short-term bond form a complete market. Agents use these bonds to finance their consumption plans. The long-term bond is bought by agents with a long habitat. The short rate is a weighted average of the short rates which prevail in homogeneous economies populated by one type of agent only. It is shown by example that heterogeneity of time preferences can produce additional humps in the yield curve.

Keywords: time preferences; term structure; interest rates; Preferred Habitat Theory; heterogeneity (search for similar items in EconPapers)
Date: 2004
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DOI: 10.1080/13518470210160885

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