Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/83694
Authors: 
García-Verdú, Santiago
Year of Publication: 
2010
Series/Report no.: 
Working Papers, Banco de México 2010-08
Abstract: 
This paper studies how inflation as a macroeconomic indicator affects nominal bond prices. I consider an economy with a representative agent with Epstein-Zin preferences. Regime switching affects the state-space capturing inêation and consumption growth. Thus, the agent is concerned about the intertemporal distribution of risk, which is affected by the persistence of the variables and the regimes. Regime switching allows for structural changes in the volatility of unexpected shocks. To the extent that inêationary unexpected shocks indicate lower consumption growth, nominal bond holders need to be compensated for these shocks. It follows that a switch in the regime state affecting the covariance of inflation and consumption growth can be interpreted as a change in the price of risk. I find coefficients of risk aversion from 40 to 90, and subjective discount factors above 0.99, depending on the exact specification of the model. The model yields have on average a positive slope, a consistent Principal Components decomposition, and predictability as in Cochrane and Piazzesi (2002).
Subjects: 
Consumption-based Asset Pricing
Regime Switching
Recursive Preferences
Yield Curve
Term Structure of Interest Rates
JEL: 
G12
E42
E43
E44
E31
Document Type: 
Working Paper
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