Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors / Antonios Sangvinatsos, Jessica A. Wachter.

Format:

Book

Author/Creator:

Sangvinatsos, Antonios.

Contributor:

National Bureau of Economic Research.

Wachter, Jessica A.

Series:

Working Paper Series (National Bureau of Economic Research) no. w10086.

NBER working paper series no. w10086

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2003.

Summary:

We consider the consumption and portfolio choice problem of a long-run investor when the term structure is affine and when the investor has access to nominal bonds and a stock portfolio. In the presence of unhedgeable inflation risk, there exist multiple pricing kernels that produce the same bond prices, but a unique pricing kernel equal to the marginal utility of the investor. We apply our method to a three-factor Gaussian model with a time-varying price of risk that captures the failure of the expectations hypothesis seen in the data. 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 for the long-run investor looks very different from the portfolio of a mean-variance optimizer. In particular, the desire to hedge changes in term premia generates large hedging demands for long-term bonds.

Notes:

Print version record

November 2003.