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 een denktank en kennisnetwerk. Netspar is gericht op een goed geïnformeerd pensioendebat.

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