Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors

We consider the consumption and portfolio choice problem of a long-run investor when the term structure is affine and when the investor has access to nominal bonds and a stock portfolio. In the presence of unhedgeable inflation risk, there exist multiple pricing kernels that produce the same bond prices, but a unique pricing kernel equal to the marginal utility of the investor. We apply our method to a three-factor Gaussian model with a time-varying price of risk that captures the failure of the expectations hypothesis seen in the data. We extend this model to account for time-varying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio for the long-run investor looks very different from the portfolio of a mean-variance optimizer. In particular, the desire to hedge changes in term premia generates large hedging demands for long-term bonds.

Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors

We consider the consumption and portfolio choice problem of a long-run investor when the term structure is affine and when the investor has access to nominal bonds and a stock portfolio. In the presence of unhedgeable inflation risk, there exist multiple pricing kernels that produce the same bond prices, but a unique pricing kernel equal to the marginal utility of the investor. We apply our method to a three-factor Gaussian model with a time-varying price of risk that captures the failure of the expectations hypothesis seen in the data. We extend this model to account for time-varying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio for the long-run investor looks very different from the portfolio of a mean-variance optimizer. In particular, the desire to hedge changes in term premia generates large hedging demands for long-term bonds

Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?

We solve the portfolio problem of a long-run investor when the term structure is Gaussian and when the investor has access to nominal bonds and stock. We apply our method to a three-factor model that captures the failure of the expectations hypothesis. We extend this model to account for time-varying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio of a long-run investor looks very different from the portfolio of a mean-variance optimizer. In particular, time-varying term premia generate large hedging demands for long-term bonds

Does the Failure of the Expectations Hypothesis Matter for Long-Term Investors?

We solve the portfolio problem of a long-run investor when the term structure is Gaussian and when the investor has access to nominal bonds and stock. We apply our method to a three-factor model that captures the failure of the expectations hypothesis. We extend this model to account for time-varying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio of a long-run investor looks very different from the portfolio of a mean-variance optimizer. In particular, time-varying term premia generate large hedging demands for long-term bonds

Does the failure of the expectations hypothesis matter for long-term investors?

We consider the consumption and portfolio choice problem of a long-run investor when the term structure is affine and when the investor has access to nominal bonds and a stock portfolio. In the presence of unhedgeable inflation risk, there exist multiple pricing kernels that produce the same bond prices, but a unique pricing kernel equal to the marginal utility of the investor. We apply our method to a three-factor Gaussian model with a time-varying price of risk that captures the failure of the expectations hypothesis seen in the data. We extend this model to account for time-varying expected inflation, and estimate the model with both inflation and term structure data. The estimates imply that the bond portfolio for the long-run investor looks very different from the portfolio of a mean-variance optimizer. In particular, the desire to hedge changes in term premia generates large hedging demands for long-term bonds