A Production-Based Model for the Term Structure
This paper considers the term structure of interest rates implied by a production-based asset pricing model where the fundamental drivers are investment in equipment and structures, and inflation. The model matches the average yield curve up to five year maturity almost perfectly. Longer term yields are roughly as volatile as in the data. The model also generates time-varying bond risk premiums. In particular, when running Fama-Bliss regressions of excess returns on forward premiums, the model produces slope coefficients of roughly half the size of the empirical counterparts. Closed-form expressions highlight the importance of the capital depreciation rates for interest rate dynamics.
I gratefully acknowledge comments from Andy Abel, Yasser Boualam, David Chapman, Nick Roussanov, and a referee, as well as from seminar and conference participants at various venues. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.