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Bond Risk Premia in Consumption-based Models

date Date: April 2, 2015
date Author(s): Drew D. Creal, Jing Cynthia Wu
date Affiliation: University of Chicago
Abstract

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.

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