Incomplete markets, liquidation risk and the term structure of interest rates

Edouard Challe, François Le Grand and Xavier Ragot
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François Le Grand: PJSE - Paris-Jourdan Sciences Economiques - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École nationale des ponts et chaussées - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École nationale des ponts et chaussées - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement

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Abstract: We construct a general equilibrium model with incomplete markets and borrowing constraints, in order to study the term structure of real interest rates. Agents are subject to both aggregate and idiosyncratic income shocks, which latter may force them into early portfolio liquidation whilst in recession. We derive a closed-form equilibrium with limited agents heterogeneity (despite market incompleteness), which allows us to derive analytical expressions for bond prices and returns at any maturity. The desirability of bonds as liquidity makes the aggregate bond demand downward-sloping. One consequence of this is that a larger bond supply raises both the level and the slope of the yield curve.

Keywords: incomplete markets; yield curve; credit constraints (search for similar items in EconPapers)
Date: 2007-12
Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-00587679v1
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Related works:
Journal Article: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2013)
Working Paper: Incomplete markets, liquidation risk, and the term structure of interest rates (2010)
Working Paper: Incomplete markets, liquidation risk and the term structure of interest rates (2007)
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