Limited Household Risk Sharing: General Equilibrium Implications for the Term Structure of Interest Rates
Abstract: We present a theory in which limited risk sharing of idiosyncratic labor income risk plays a key role in determining the dynamics of interest rates. Our production-based model relates the cross-sectional distribution of labor income risk to observable aggregate labor market variables. Our model makes two key predictions. First, it predicts positive risk premia for long-term bonds while simultaneously matching key macroeconomic moments. Second, it predicts a negative correlation between current labor market conditions (as measured by labor market tightness or the job-finding rate) and future bond excess returns. We provide evidence for these predictions.
Status: Published in 2020
File(s): File format is application/pdf https://www.frbatlanta.org/-/media/documents/research/publications/wp/2020/11/09/20-general-equilibrium-implications-for-term-structure-of-interest-rates.pdf
Provider: Federal Reserve Bank of Atlanta
Part of Series: FRB Atlanta Working Paper
Publication Date: 2020-11-09