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Journal of Economic Theory and Econometrics
JETEM/계량경제학보/計量經濟學報/JKES
Journal of the Korean Econometric Society

On the Connection between the Expectations Hypothesis of the Term Structure of Interest Rates and Risk Neutrality

Vol.17, No.1, March , 23–38



  •   (College of Business Administration, Seoul National University)

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Abstract  

Using the non-expected recursive utility function of Epstein and Zin (1989), this paper re-examines the connection between the expectations hypothesis of the term structure theory and risk neutrality in three-date general equilibria. Major findings are: (i) To generate stochastic future interest rates in risk neutral economies, disentangling agents' two disparate preference components - intertemporal substitution and risk aversion - is critically important; (ii) As a result, term premia are non-zero and thus the expectations hypothesis does not hold under risk neutrality. These non-zero term premia are characterized as compensations for the investor being averse to intertemporal substitution.


Keywords
   Term Structure, Expectations Hypothesis, Risk Neutrality, Non-expected Utility

JEL classification codes
   E43, G12
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