The Journal of Finance publishes leading research across all the major fields of finance. It is one of the most widely cited journals in academic finance, and in all of economics. Each of the six issues per year reaches over 8,000 academics, finance professionals, libraries, and government and financial institutions around the world. The journal is the official publication of The American Finance Association, the premier academic organization devoted to the study and promotion of knowledge about financial economics.
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Equilibrium Interest Rates and Multiperiod Bonds in a Partially Observable Economy
Published: 06/01/1986 | DOI: 10.1111/j.1540-6261.1986.tb05042.x
MICHAEL U. DOTHAN, DAVID FELDMAN
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.