Ambiguity Aversion and the Term Structure of Interest Rates

Laurent Barras, Patrick Gagliardini (), Paolo Porchia and Fabio Trojani ()
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Laurent Barras: Imperial College, Tanaka Business School and Swiss Finance Institute
Paolo Porchia: University of St. Gallen

No 08-19, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: This paper studies the termstructure implications of a simple structuralmodel inwhich the representative agent displays ambiguity aversion, modeled by Multiple Priors Recursive Utility. Bond excess returns reflect a premium for ambiguity, which is observationally distinct from the risk premium of affine yield curve models. The ambiguity premium can be large even in the simplest log-utility setting and is non zero also for stochastic factors that have a zero risk premium. A calibrated low-dimensional two-factor model with ambiguity is able to reproduce the deviations from the expectations hypothesis documented in the literature, without modifying in a substantial way the nonlinear mean reversion dynamics of the short interest rate. Moreover, the model does not imply any apparent tradeoff between fitting the first and second moments of the yield curve.

Keywords: General Equilibrium; Term Structure of Interest Rates; Ambiguity Aversion; Expectations; Hypothesis; Campbell-Shiller Regression (search for similar items in EconPapers)
JEL-codes: C68 G12 G13 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2008-08
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Ambiguity Aversion and the Term Structure of Interest Rates (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp0819

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