| Abstract: | The assumption of habit formation in preferences induces two effects on time series of agents' marginal utility of consumption: greater volatility relative to standard time-separable preferences and negative serial correlation. This paper examines whether the second property can help explain the behavior of the nominal term premium. A cash-in-advance model of interest rates is appended with a model of habit persistence and calibrated to U.S. data. Using yields on three- and six-month U.S. Treasury Bills for comparison, we find the model can indeed duplicate the observed average term premium, but cannot account for the term premium's volatility. |
