The Model Of Term Structure Of Interest Rate Based On Habit Formation

There are various interest rates simultaneously in the economy. Ceteris paribus, this relationship is called the term structure of interest rates that interest rates of different term bonds are different. The term structure of interest rates is applied widely to the forecast of macroeconomic variables, the monetary policy operations of central bank, the risk management of financial institutions, asset pricing and financial derivatives development. Habit-based utility function is applied widely in financial economics, but it is mainly applied in stock maket, seldom applied in bond maket. Expectation hypothesis is used to account for the cause of term structure, while empirical studies on bond maket mostly reject this hypothesis. Expectations puzzle is documented further that posed a challenge for models of the term structure. Effecting ones’risk preference, consumpion habit can generat time-varying term premium, and this provide an economic explaination for expectations puzzle. This paper study on how habit formation influence term structure, and apply one model related to empirically analyse China bond maket. This paper firstly sorts the literatures of habit formation and term structure, and reviews the development course of habit formation and term structure of interest rate theory and its application to find the logic and ways to combine them. Secondly, build a basic analysis framework, and introduce three models from foreign literatures, Dai model, Watchter model and BJ model. Three models differ from each other in economic structure assumptions and habit formation setting and so on, then analyse the different characteristics and relations among them. Because Watchter model is more popular, finally use Watchter model and Watchter’s method to study China bond maket, but the expected result is not obtained. At the end of the article, summarize this paper and put forward research prospect and the possible reasons for the failures of the empirical result.