Term Structure of Interest Rates under Recursive Preferences in Continuous Time ( Revised in February 2008, subsequently published in "Asia-Pacific Financial Markets", Vol.15-3,4, 273-305. )

Hisashi Nakamura, Keita Nakayama and Akihiko Takahashi
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Hisashi Nakamura: Faculty of Economics, University of Tokyo
Keita Nakayama: Graduate School of Economics, University of Tokyo
Akihiko Takahashi: Faculty of Economics, University of Tokyo

No CARF-F-118, CARF F-Series from Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo

Abstract: This paper proposes a testable continuous-time term-structure model with recursive utility to investigate structural relationships between the real economy and the term structure of real and nominal interest rates. In a representative-agent model with recursive utility and mean-reverting expectations on real output growth and inflation, this paper shows that, if (1) real short-term interest rates are high during economic booms and (2) the agent is comparatively risk-averse (less risk-averse) relative to time-separable utility, then a real yield curve slopes down (slopes up, respectively). Additionally, for the comparatively risk-averse agent, if (3) expected inflation is negatively correlated with the real output and its expected growth, then a nominal yield curve can slope up, regardless of the slope of the real yield curve.

Pages: 32 pages
Date: 2008-01
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Persistent link: https://EconPapers.repec.org/RePEc:cfi:fseres:cf118

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