Bond Risk Premia in Consumption-based Models

Drew Creal and Jing Cynthia Wu

No 22183, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Workhorse Gaussian affine term structure models (ATSMs) attribute time-varying bond risk premia entirely to changing prices of risk, while structural models with recursive preferences credit it completely to stochastic volatility. We reconcile these competing channels by introducing a novel form of external habit into an otherwise standard model with recursive preferences. The new model has an ATSM representation with analytical bond prices making it empirically tractable. We find that time variation in bond term premia is predominantly driven by the price of risk, especially, the price of expected inflation risk that co-moves with expected inflation itself.

JEL-codes: C11 E31 E43 E52 G12 (search for similar items in EconPapers)
Date: 2016-04
New Economics Papers: this item is included in nep-mac, nep-pke and nep-upt
Note: AP EFG ME
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Citations: View citations in EconPapers (11)

Published as Drew D. Creal & Jing Cynthia Wu, 2020. "Bond risk premia in consumption‐based models," Quantitative Economics, Econometric Society, vol. 11(4), pages 1461-1484, November.

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