Present Bias, Asset Allocation and the Yield Curve

This paper presents a present-biased general equilibrium model that explains many features of bond behavior. Present-biased investors increase (decrease) short-term (long-term) hedge demands compared to standard preferences. Hence, present bias drives up (down) short-term bond prices (yields) and drives down (up) long-term bond prices (yields), explaining the bond premium puzzle. The model produces realistic bond behavior with a present-bias factor of 0.35 and a long-term annual discount factor of 0.97, in line with the experimental literature. Bond behavior is best explained for a present-bias interval of at most 1 year, providing an estimate for the investor’s duration of the present.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

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