The literature on recursive preference attributes all the time variation in bond risk premia to stochastic volatility. We introduce another source: time-varying prices of risk that co-move with inflation and consumption growth through a preference shock. We find that a time-varying price of risk driven by inflation dominates stochastic volatility in contributing to time variation in term premia. Once preference shocks are present, term premia are economically the same with or without stochastic volatility.
Bond Risk Premia in Consumption-based Models
Submitted by Staff on November 10, 2015
|Date: April 2, 2015|
|Author(s): Drew D. Creal, Jing Cynthia Wu|
|Affiliation: University of Chicago|