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American Economic Journal: Macroeconomics: Vol. 4 No. 1 (January 2012)

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The Bond Premium in a DSGE Model with Long-Run Real and Nominal Risks

Article Citation

Rudebusch, Glenn D., and Eric T. Swanson. 2012. "The Bond Premium in a DSGE Model with Long-Run Real and Nominal Risks." American Economic Journal: Macroeconomics, 4(1): 105-43.

DOI: 10.1257/mac.4.1.105

Abstract

The term premium in standard macroeconomic DSGE models is far too small and stable relative to the data—an example of the "bond premium puzzle." However, in endowment economy models, researchers have generated reasonable term premiums by assuming investors have recursive Epstein-Zin preferences and face long-run economic risks. We show that introducing Epstein-Zin preferences into a canonical DSGE model can also produce a large and variable term premium without compromising the model's ability to fit key macroeconomic variables. Long-run nominal risks further improve the model's empirical fit, but do not substantially reduce the need for high risk aversion. (JEL E13, E31, E43, E44)

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Authors

Rudebusch, Glenn D. (Federal Reserve Bank of San Francisco)
Swanson, Eric T. (Federal Reserve Bank of San Francisco)

JEL Classifications

E13: General Aggregative Models: Neoclassical
E31: Price Level; Inflation; Deflation
E43: Interest Rates: Determination, Term Structure, and Effects
E44: Financial Markets and the Macroeconomy

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