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Pricing the Planet's FutureThe Economics of Discounting in an Uncertain World$
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Christian Gollier

Print publication date: 2012

Print ISBN-13: 9780691148762

Published to University Press Scholarship Online: October 2017

DOI: 10.23943/princeton/9780691148762.001.0001

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A Theory of the Decreasing Term Structure of Discount Rates

A Theory of the Decreasing Term Structure of Discount Rates

Chapter:
(p.111) 8 A Theory of the Decreasing Term Structure of Discount Rates
Source:
Pricing the Planet's Future
Author(s):

Christian Gollier

Publisher:
Princeton University Press
DOI:10.23943/princeton/9780691148762.003.0008

This chapter aims to provide a unified theoretical foundation to the term structure of discount rates. To do this the chapter develops a benchmark model based on two assumptions: individual preferences toward risk, and the nature of the uncertainty over economic growth. Previously, it was shown that constant relative risk aversion, combined with a random walk for the growth of log consumption, yields a flat term structure for efficient discount rates. In this chapter, these two assumptions are relaxed by using a stochastic dominance approach. Stochastic models of economic growth with mean-reversion, Markov switches, and parametric uncertainty all exhibit some forms of positive statistical dependence of successive growth rates. Because this tends to magnify the long-term risk, it is the driving force of the decreasing nature of the term structure.

Keywords:   concordance, term structure, risk preferences, uncertainty, risk aversion, random walk, stochastic dominance approach, economic growth rates, long-term risk

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