Date of this Version
The Journal of Finance
We solve the portfolio problem of a long-run investor when the term structure is Gaussian and when the investor has access to nominal bonds and stock. We apply our method to a three-factor model that captures the failure of the expectations hypothesis. We extend this model to account for time-varying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio of a long-run investor looks very different from the portfolio of a mean-variance optimizer. In particular, time-varying term premia generate large hedging demands for long-term bonds.
This is the peer reviewed version of the following article, which has been published in final form at http://dx.doi.org/10.1111/j.1540-6261.2005.00728.x. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving.
Sangvinatsos, A., & Wachter, J. A. (2005). Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?. The Journal of Finance, 60 (1), 179-230. http://dx.doi.org/10.1111/j.1540-6261.2005.00728.x
Date Posted: 27 November 2017
This document has been peer reviewed.