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Bond Pricing with a Time-Varying Price of Risk in an Estimated Medium-Scale Bayesian DSGE Model



  • This paper was the second chapter of my Ph.D. dissertation. I appreciate helpful comments from the Editor and two anonymous referees, Jason Beeler, John Campbell, Emmanuel Farhi, Andrea Tambalotti, and seminar participants at the Federal Reserve Bank of Chicago.


New Keynesian model in which households have Epstein–Zin preferences with time-varying risk aversion and the central bank has a time-varying inflation target can match the dynamics of nominal bond prices in the U.S. economy well. The model generates a large steady-state term spread and its fitting errors for bond yields are comparable to those obtained from a nonstructural three-factor model, and one-third smaller than in models with a constant inflation target or risk aversion. Including data on interest rates has large effects on variance decompositions, making investment technology shocks much less important than found in other recent papers.