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Please use this identifier to cite or link to this item: http://hdl.handle.net/2451/27310

Title: Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?
Authors: Sangvinatsos, Antonios
Wachter, Jessica
Issue Date: 21-Nov-2003
Series/Report no.: S-MF-03-02
Abstract: 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.
URI: http://hdl.handle.net/2451/27310
Appears in Collections:Macro Finance

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