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Description:
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In the first essay , I decompose inflation risk into (i ) a part that is correlated with real returns on the market portfolio and factors that determine investor’s preferences and investment opportunities and (ii ) a residual part . I show that only the first part earns a risk premium . All nominal Treasury bonds , including the nominal money -market account , are equally exposed to the residual part except inflation -protected Treasury bonds , which provide a means to hedge it . Every investor should put 100 % of his wealth in the market portfolio and inflation -protected Treasury bonds and hold a zero -investment portfolio of nominal Treasury bonds and the nominal money market account .
In the second essay , I solve the dynamic asset allocation problem of finite lived , constant relative risk averse investors who face inflation risk and can invest in cash , nominal bonds , equity , and inflation -protected bonds when the investment opportunityset is determined by the expected inflation rate . I estimate the model with nominal bond , inflation , and stock market data and show that if expected inflation increases , then investors should substitute inflation -protected bonds for stocks and they should borrow cash to buy long -term nominal bonds .
In the lastessay , I discuss how heterogeneity in preferences among investors withexternal non -addictive habit forming preferences affects the equilibrium nominal term structure of interest rates in a pure continuous time exchange economy and complete securities markets . Aggregate real consumption growth and inflation are exogenously specified and contain stochastic components thataffect their means andvolatilities . There are two classes of investors who have external habit forming preferences and different localcurvatures oftheir utility functions . The effects of time varying risk aversion and different inflation regimes on the nominal short rate and the nominal market price of risk are explored , and simple formulas for nominal bonds , real bonds , and inflation risk premia that can be numerically evaluated using Monte Carlo simulation techniques are provided . |