Real Term Premia in Consumption-Based Models
Abstract: In the data, real term premia are mostly positive and time-varying. So, I analyse to what extent consumption-based mechanisms generate these features. My investigation shows that only models with time-varying risk aversion or models with high consumption risk can produce these patterns within the consumption-based framework. The latter explanation has not been suggested before, and it involves a small group of investors with risky consumption. In relation to preferences, I consider models with both time-separable and recursive utility functions. For the latter case, I introduce a novel perturbation solution method which is easy to implement and allows a wide range of values for the parameter of intertemporal elasticity of substitution.