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Habit Formation and Macroeconomic Models of the Term Structure of Interest Rates




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    • Andrea Buraschi is a Professor of Finance at Tanaka Business School, Imperial College London, CEPR and IMD. Alexei Jiltsov is at Lehman Brothers, London. We are grateful to Geert Bekaert, Mikhail Chernov, Jefferson Duarte, Francisco Gomes, Dennis Gromb, Andrew Jackson, Charles Jones, Vasant Naik, Randi Rosenblatt, Tano Santos, Raman Uppal, and Pietro Veronesi for their suggestions, and to an anonymous referee whose comments greatly improved the paper. We are also grateful to workshops participants at Columbia Business School, European Central Bank, the Gerzensee Summer Symposium, Lehman Brothers, London Business School, Imperial College London, University of St. Gallen, University of Amsterdam, University of Mannheim, and the University of Frankfurt for their comments. The usual disclaimer applies.


This paper introduces a new class of nonaffine models of the term structure of interest rates that is supported by an economy with habit formation. Distinguishing features of the model are that the interest rate dynamics are nonlinear, interest rates depend on lagged monetary and consumption shocks, and the price of risk is not a constant multiple of interest rate volatility. We find that habit persistence can help reproduce the nonlinearity of the spot rate process, the documented deviations from the expectations hypothesis, the persistence of the conditional volatility of interest rates, and the lead-lag relationship between interest rates and monetary aggregates.

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