The bond premium in a DSGE model with long-run real and nominal risks

Glenn Rudebusch and Eric Swanson

No 2008-31, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: The term premium on nominal long-term bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data--an example of the ''bond premium puzzle.'' However, in models of endowment economies, researchers have been able to generate reasonable term premiums by assuming that investors have recursive Epstein-Zin preferences and face long-run economic risks. We show that introducing Epstein-Zin preferences into a canonical DSGE model can also produce a large and variable term premium without compromising the model's ability to fit key macroeconomic variables. Long-run real and nominal risks further improve the model's ability to fit the data with a lower level of household risk aversion.

Keywords: Interest rates; Econometric models (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-cba, nep-dge and nep-mac
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Citations: View citations in EconPapers (8)

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Related works:
Journal Article: The Bond Premium in a DSGE Model with Long-Run Real and Nominal Risks (2012)
Working Paper: The bond premium in a DSGE model with long-run real and nominal risks (2008)
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