Real risk premia in segmented asset markets

Using UK real yield data I estimate the quadratic term structure model derived from the second order approximation to the marginal utility of agents in an economy with endogenously segmented asset markets. Asset market participation is limited by heterogeneous fixed transaction costs. The estimates suggest that the implied consumption of active households has constant conditional variances, and varies more in response to money shocks when inflation is close to its unconditional mean. The model generates the predictability coefficients consistent with time-varying real risk premia observed in the UK data. Endogenous asset market segmentation is the economic mechanism that generates the rejection of the expectations hypothesis in real rates.