Observable Long-Run Ambiguity and Long-Run Risk

This paper derives and estimates a general equilibrium model for the real and nominal term structure of U.S. government bonds with only observable macro variables. The model takes into account that investors are confronted with a set of multiple long-run risk models. The paper accounts for model misspecification doubts about long-run GDP risk and about long-run inflation risk. We find that an increase in macro uncertainty leads to a steepening in TIPS and nominal yields. Increased uncertainty about the long-run GDP model generates a steeper slope in TIPS yields than the inflation uncertainty counterpart. But on the other hand, we find that the term premium in TIPS and nominal bond yields is dominated by model uncertainty about long-run inflation. The estimated robustness preference for ambiguity about long-run inflation is 7.6 and 0.3 for long-run GDP ambiguity.