American Economic Review Vol. 91 No. 1 2001

Who Should Buy Long-Term Bonds?

John Y. Campbell¹; Luis M. Viceira²

¹ Department of Economics, Littauer Center 213, Harvard University, Cambridge, MA 02138, and National Bureau of Economic Research. · ² Harvard Business School, Morgan Hall 367, Harvard University, Boston, MA 02163, National Bureau of Economic Research, and Centre for Economic Policy Research.

Abstract

According to conventional wisdom, long-term bonds are appropriate for conservative long-term investors. This paper develops a model of optimal consumption and portfolio choice for infinite-lived investors with recursive utility who face stochastic interest rates, solves the model using an approximate analytical method, and evaluates conventional wisdom. As risk aversion increases, the myopic component of risky asset demand disappears but the intertemporal hedging component does not. Conservative investors hold assets to hedge the risk that real interest rates will decline. Long-term inflation-indexed bonds are most suitable for this purpose, but nominal bonds may also be used if inflation risk is low.

DOI

10.1257/aer.91.1.99

Volume

91

Issue

1

Pages

99-127

Language

en

Sources

bibtex:phds-export.bib crossref openalex

Cite

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