Robust Equilibrium Yield Curves

Isaac Kleshchelski and Nicolas Vincent

No 08-02, Cahiers de recherche from HEC Montréal, Institut d'économie appliquée

Abstract: This paper studies the quantitative implications of the interaction between robust control and stochastic volatility for key asset pricing phenomena. We present an equilibrium term structure model with a representative agent and an output growth process that is conditionally heteroskedastic. The agent does not know the true model of the economy and chooses optimal policies that are robust to model misspecification. The choice of robust policies greatly amplifies the effect of conditional heteroskedasticity in consumption growth, improving the model’s ability to explain asset prices. In a robust control framework, stochastic volatility in consumption growth generates both a state-dependent market price of model uncertainty and a stochastic market price of risk. We estimate the model using data from the bond and equity markets, as well as consumption data. We show that the model is consistent with key empirical regularities that characterize the bond and equity markets. We also characterize empirically the set of models the robust representative agent entertains, and show that this set is ?small?. That is, it is statistically difficult to distinguish between models in this set.

Keywords: Yield curves; Market price of Uncertainty; Robust control. (search for similar items in EconPapers)
JEL-codes: D81 E43 G11 G12 (search for similar items in EconPapers)
Pages: 67 pages
Date: 2007-11
New Economics Papers: this item is included in nep-dge, nep-fmk and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Working Paper: Robust Equilibrium Yield Curves (2009)
Working Paper: Robust Equilibrium Yield Curves (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:iea:carech:0802

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