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A consumption-based term structure model of bonds and equity

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  • Suzuki, Masataka

Abstract

In this study, I propose a consumption-based asset pricing model to capture the dynamic properties of term structures of bonds and equity. I extend the long-run risks model by introducing a mean-reversion of dividend growth and the external habit formation of a representative agent. The mean-reverting dividend growth generates a negative equity term premium, while the habit formation augments the equity premium and renders an upward-sloping bond yield curve, on average. In addition, fluctuations in the surplus consumption ratio and the conditional variance of consumption growth allow the model to reproduce pro-cyclical variations in bond and equity yield spreads and counter-cyclical variations in bond and equity term premiums, as observed in the U.S. data.

Suggested Citation

  • Suzuki, Masataka, 2024. "A consumption-based term structure model of bonds and equity," International Review of Financial Analysis, Elsevier, vol. 94(C).
    • Handle: RePEc:eee:finana:v:94:y:2024:i:c:s1057521924002424
    DOI: 10.1016/j.irfa.2024.103310
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    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Term structure; Consumption-based asset pricing model; Long-run risks; Habit formation;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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