Explaining bond returns in heterogeneous agent models: The importance of higher-order moments

This paper examines the higher-order moments and nonlinear dynamic properties of discount bond returns in an equilibrium heterogeneous agent economy with incomplete markets and borrowing constraints. We find that while it is possible for the economic model to match the mean and variance of the observed bond returns by choosing the parameters such that the borrowing constraint is binding sufficiently often, the implied higher-order moments are at odds with the data. To match the higher-order moments, one needs a model in which the borrowing constraint is binding at times but not too often. In this case, one does not match the first two moments. Using the seminonparametric density estimation and the nonlinear impulse response analysis, we find that our economic model can mimic the asymmetric effect of return shocks on conditional volatility as documented for the real bond returns. However, the economic model has difficulty replicating the dynamic properties observed in the data when the parameter values are chosen to match the first two moments of the observed bond returns. (C) 2000 Elsevier Science B.V. All rights reserved. JEL classification: C14; E44; G12.