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"the Term Structure of Real Interest Rates: Theory and Evidence from UK Index-Linked Bonds"

Juha Seppala

 

First Author :

Juha Seppala
Economics
University of Illinois at Urbana-Champaign
1206 S. Sixth Street, M/C 706
Champaign, IL 61820
USA

seppala@uiuc.edu

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Abstract :
 
This paper studies the behavior of the default-risk-free real term structure and term premia in two general equilibrium endowment economies with complete markets but without money. In the first economy there are no frictions as in Lucas (1978) and in the second risk-sharing is limited by the risk of default as in Alvarez and Jermann (2000ab). Both models are solved numerically, calibrated to UK aggregate and household data, and the predictions are compared to data on real interest rates constructed from the UK index-linked data. While both models produce time-varying risk or term premia, only the model with limited risk-sharing can generate enough variation in the term premia to account for the rejections of expectations hypothesis.
 
 
JEL Classification : E43 , E44 , G12
 
 
Keywords :
 
Default risk, General equilibrium, Index-linked bonds, Term premia, Term structure of interest rates
 
 
Manuscript Received : 2000
Manuscript Published : 2000
 
 
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