Summary
In this paper we present a model of the term structure of interest rates with imperfect information and stochastic differential utility, a form of non-additive recursive utility. A principal feature of recursive utility, that distinguishes it from time-separable expected utility, is its dependence on the timing of resolution of uncertainty. In our model, we parametrize the nonlinearity of recursive utility in a way that corresponds to preferences for the timing of resolution. This way we show explicitly the dependence of prices on the rate of information, as a consequence of the nature of utilities. State prices and the term structure of interest rates are obtained in closed form, and are shown to have a form in which derivative asset pricing is tractable. Comparative statics relating to the dependence of the term structure on the rate of information are also discussed.
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We thank Bob Hodrick and Matt Jackson for their comments. Darrell Duffie is grateful for support from the National Science Foundation under NSF SBR-9409567. This paper presents the first model of an earlier, preliminary working paper titled: “Two models of price dependence on the timing of resolution of uncertainty.”
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Duffie, D., Schroder, M. & Skiadas, C. A term structure model with preferences for the timing of resolution of uncertainty. Econ Theory 9, 3–22 (1997). https://doi.org/10.1007/BF01213440
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DOI: https://doi.org/10.1007/BF01213440