2013-09-25Buch DOI: 10.18452/4483
Testing the Preferred-Habitat Theory
Role of Time-Varying Risk Aversion
Testing the Preferred-Habitat Theory: The Role ofTime-Varying Risk Aversion Abstract: This paper examines the preferred-habitat theory under time-varying risk aversion. The predicted positive relation between the term spread and relative supply of longer-term debt is stronger when risk aversion is high. To capture this effect, a time-varying coefficient model is introduced and applied to German bond data. The results support the theoretical predictions and indicate substantial time variation: under high risk aversion, yield spreads react about three times more strongly than when risk aversion is low. The accumulated response of term spreads to a one standard deviation change in debt supply ranges between 5 and 33 basis points.
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