Ambiguity Aversion and the Term Structure of Interest Rates

Posted: 28 Sep 2009

See all articles by Patrick Gagliardini

Patrick Gagliardini

University of Lugano; Swiss Finance Institute

Paolo Porchia

IE Business School

Fabio Trojani

Swiss Finance Institute; University of Geneva

Multiple version iconThere are 2 versions of this paper

Date Written: October 2009

Abstract

This paper studies the term structure implications of a simple structural model in which the representative agent displays ambiguity aversion, modeled by Multiple Priors Recursive Utility. Bond excess returns reflect a premium for ambiguity, which is observationally distinct from the risk premium of affine yield curve models. The ambiguity premium can be large even in the simplest log-utility setting and is also nonzero for stochastic factors that have a zero risk premium. A calibrated low-dimensional two-factor model with ambiguity is able to reproduce the deviations from the expectations hypothesis documented in the literature, without modifying in a substantial way the nonlinear mean-reversion dynamics of the short interest rate. Moreover, the model does not imply any apparent trade-off between fitting the first and second moments of the yield curve.

Keywords: C68, G12, G13

Suggested Citation

Gagliardini, Patrick and Porchia, Paolo and Trojani, Fabio, Ambiguity Aversion and the Term Structure of Interest Rates (October 2009). The Review of Financial Studies, Vol. 22, Issue 10, pp. 4157-4188, 2009, Available at SSRN: https://ssrn.com/abstract=1478809 or http://dx.doi.org/hhn092

Patrick Gagliardini (Contact Author)

University of Lugano ( email )

Via Buffi 13
Lugano, TN 6900
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Paolo Porchia

IE Business School ( email )

Serrano 99
Madrid, 28006
Spain
+34917821706 (Phone)
+34 91 745 47 62 (Fax)

HOME PAGE: http://paolo-porchia.profesores.ie.edu/

Fabio Trojani

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

University of Geneva ( email )

Geneva, Geneva
Switzerland

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