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Habit Persistence and the Nominal Term Premium Puzzle: A Partial Resolution

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  • Salyer, Kevin D

Abstract

The assumption of habit formation in preferences induces two effects on time series of agents' marginal utility of consumption: greater volatility relative to standard time-separable preferences and negative serial correlation. This paper examines whether the second property can help explain the behavior of the nominal term premium. A cash-in-advance model of interest rates is appended with a model of habit persistence and calibrated to U.S. data. Using yields on three- and six-month U.S. Treasury Bills for comparison, the author finds the model can indeed duplicate the observed average term premium but cannot account for the term premium's volatility. Copyright 1995 by Oxford University Press.

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  • Salyer, Kevin D, 1995. "Habit Persistence and the Nominal Term Premium Puzzle: A Partial Resolution," Economic Inquiry, Western Economic Association International, vol. 33(4), pages 672-691, October.
    • Handle: RePEc:oup:ecinqu:v:33:y:1995:i:4:p:672-91
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    Cited by:

    1. Brandt, Michael W. & Wang, Kevin Q., 2003. "Time-varying risk aversion and unexpected inflation," Journal of Monetary Economics, Elsevier, vol. 50(7), pages 1457-1498, October.
    2. Salyer, Kevin D., 1998. "Crash states and the equity premium: Solving one puzzle raises another," Journal of Economic Dynamics and Control, Elsevier, vol. 22(6), pages 955-965, June.
    3. Xu, Yuan, 2015. "Robustness to model uncertainty and the nominal term premium puzzle," Journal of Macroeconomics, Elsevier, vol. 44(C), pages 124-137.

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