Finance Papers

Document Type

Journal Article

Date of this Version

2006

Publication Source

Journal of Financial Economics

Volume

79

Issue

2

Start Page

365

Last Page

399

DOI

10.1016/j.jfineco.2005.02.004

Abstract

This paper proposes a consumption-based model that accounts for many features of the nominal term structure of interest rates. The driving force behind the model is a time-varying price of risk generated by external habit. Nominal bonds depend on past consumption growth through habit and on expected inflation. When calibrated to data on consumption, inflation, and the aggregate market, the model produces realistic means and volatilities of bond yields and accounts for the expectations puzzle. The model also captures the high equity premium and excess stock market volatility.

Copyright/Permission Statement

© 2006. This manuscript version is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/.

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Date Posted: 27 November 2017

This document has been peer reviewed.