Post by Sapphire Capital on Jul 16, 2008 20:07:01 GMT 4
Consumption Risk and the Real Yield Curve
SHU WU
The University of Kansas - Department of Economics
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May 6, 2008
Abstract:
This paper estimates the joint dynamics of consumption growth and the long end of the real yield curve using an arbitrage-free term structure model with flexible specifications of market prices of risk. The model allows us to extract from prices of long-lived real bonds a small but persistent long-run component of consumption growth as well as time-varying levels of growth volatility. Consistent with the predications of recent long-run risk models, we find strong evidence that both risks are priced. The long-run consumption risk in fact dominates the short-run and consumption volatility risks and drives most of the variations in bond risk premiums. The risk premium for consumption volatility is negative, suggesting that long-term real bonds provide an effective hedge against the volatility risk in consumption growth. The short-run consumption risk commands a small risk premium. Stochastic growth volatility alone, however, is not sufficient to account for the time variations in bond risk premiums.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1130087_code279093.pdf?abstractid=1130087&mirid=3
SHU WU
The University of Kansas - Department of Economics
--------------------------------------------------------------------------------
May 6, 2008
Abstract:
This paper estimates the joint dynamics of consumption growth and the long end of the real yield curve using an arbitrage-free term structure model with flexible specifications of market prices of risk. The model allows us to extract from prices of long-lived real bonds a small but persistent long-run component of consumption growth as well as time-varying levels of growth volatility. Consistent with the predications of recent long-run risk models, we find strong evidence that both risks are priced. The long-run consumption risk in fact dominates the short-run and consumption volatility risks and drives most of the variations in bond risk premiums. The risk premium for consumption volatility is negative, suggesting that long-term real bonds provide an effective hedge against the volatility risk in consumption growth. The short-run consumption risk commands a small risk premium. Stochastic growth volatility alone, however, is not sufficient to account for the time variations in bond risk premiums.
papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1130087_code279093.pdf?abstractid=1130087&mirid=3