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Equilibrium Interest Rates and Multiperiod Bonds in a Partially Observable Economy
Author(s) -
DOTHAN MICHAEL U.,
FELDMAN DAVID
Publication year - 1986
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1986.tb05042.x
Subject(s) - unobservable , economics , bond , interest rate , portfolio , consumption (sociology) , econometrics , investment (military) , financial market , production (economics) , spot contract , hedge , microeconomics , futures contract , financial economics , monetary economics , finance , ecology , social science , sociology , politics , political science , law , biology
ABSTRACT This paper analyzes the market for financial assets in a production and exchange economy with several realized outputs and a single unobservable source of nondiversifiable risk. The paper demonstrates that, for a large class of diffusion outputs and preferences, optimizing consumers first estimate the realizations of the unobservable factor and then use these estimates to determine portfolio and consumption rules. Moreover, the explicit consideration of this unobservable productivity factor affects equilibrium demands and prices. The equilibrium spot rate of interest emerges as the “best estimate” of the unobservable factor, and multiperiod default‐free bonds arise as the optimal hedge for the unobservable changes of the stochastic investment opportunity set.