CIRJE-F-603. Nakamura, Hisashi, Wataru Nozawa and Akihiko Takahashi, "Macroeconomic Implications of Term Structures of Interest Rates under Stochastic Differential Utility with Non-Unitary IES", November 2008.

This paper proposes a continuous-time term-structure model under stochastic differential utility with non-unitary intertemporal elasticity of substitution (IES, henceforth) in a representative-agent endowment economy with mean-reverting expectations on real output growth and ination. Using this model, we make clear structural relationships among a term structure of real and nominal interest rates, utility form and underlying economic factors, in particular, ination expectation. Specifically, we show that, if (1) the IES is less than one, (2) the agent is comparatively more risk-averse relative to time-separable utility, (3) short-term interest rates are pro-cyclical, and (4) the rate of expected ination is negatively correlated with the rate of real output growth and its expected rate, then a nominal yield curve can have a low instantaneous riskless rate and an upward slope.