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Term structure dynamics in a monetary economy with learning

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  • Ono, Sadayuki
Abstract
This paper investigates a continuous-time monetary asset-pricing model of the term structure of nominal interest rates. In a pure exchange economy with incomplete information, investors cannot observe the expected growth rates of both exogenous real output and money supply. Therefore, they apply dynamic Bayesian inference. The model obtains explicit solutions for equilibrium prices of consumption goods and nominal bonds, and the stochastic process of an investor’s beliefs. The dependence of term premia on beliefs allows the model to introduce a GARCH property, which interacts with the volatility of the macro variables. In particular, the volatility of excess returns is inversely related to noise in the macro variables, suggesting that their imprecise information does not increase fluctuations in interest rates. Using beliefs as the factor of uncertainties in economic states, the model also shows that there is a negative correlation between the new measure of uncertainty and the velocity of money, consistent with Friedman’s explanation that demand for money for precautionary motives has a negative impact on the velocity.

Suggested Citation

  • Ono, Sadayuki, 2019. "Term structure dynamics in a monetary economy with learning," The North American Journal of Economics and Finance, Elsevier, vol. 48(C), pages 730-745.
    • Handle: RePEc:eee:ecofin:v:48:y:2019:i:c:p:730-745
    DOI: 10.1016/j.najef.2018.08.005
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    More about this item

    Keywords

    Term structure of interest rates; Monetary asset-pricing model; Uncertainty in parameters; Learning;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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