Working Paper
Examining the bond premium puzzle with a DSGE model
Abstract: The basic inability of standard theoretical models to generate a sufficiently large and variable nominal bond risk premium has been termed the \"bond premium puzzle.\" We show that the term premium on long-term bonds in the canonical dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to the data. We find that introducing long-memory habits in consumption as well as labor market frictions can help fit the term premium, but only by seriously distorting the DSGE model's ability to fit other macroeconomic variables, such as the real wage; therefore, the bond premium puzzle remains.
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Bibliographic Information
Provider: Federal Reserve Bank of San Francisco
Part of Series: Working Paper Series
Publication Date: 2008
Number: 2007-25