Incomplete markets, liquidation risk, and the term structure of interest rates

Edouard Challe, F. Le Grand and Xavier Ragot

Working papers from Banque de France

Abstract: We analyze the term structure of real interest rates in a general equilibrium model with incomplete markets and borrowing constraints. Agents are subject to both aggregate and idiosyncratic income shocks, which latter may force them into early portfolio liquidation in a bad aggregate state. We derive a closed-form equilibrium with limited agent heterogeneity (despite market incompleteness), which allows us to produce analytical expressions for bond prices and returns at any maturity. The attractiveness of bonds as liquidity makes aggregate bond demand downward-sloping, so that greater bond supply raises both the level and the slope of the yield curve. Moreover, time-variations in liquidation risk are shown to help explain the rejection of the Expectations Hypothesis.

Keywords: Incomplete markets; yield curve; borrowing constraints. (search for similar items in EconPapers)
JEL-codes: E21 E43 G12 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2010
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Journal Article: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk and the term structure of interest rates (2007)
Working Paper: Incomplete markets, liquidation risk and the term structure of interest rates (2007)
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