The Cyclical Behavior of the Real Term Structure and Consumption Growth

A complete markets consumption-based asset pricing model predicts that the behavior of expected real yields on nominally risk free bonds should be closely related to expected consumption growth, adjusted by the variance of consumption growth. In this paper, expected real yields and expected consumption growth are identified using time series models, and the stylized facts about real yields, consumption growth, and their variability over the business cycle are examined. The principal results are: (1) Real yields are substantially more persistent than consumption growth. Nevertheless (2) Variation of real yields and consumption growth over the business cycle are qualitatively similar. They are both positively correlated with the cyclical component of the natural logarithm of output, and contrary to the predictions in Breeden (1986) and Donaldson, Johnsen, and Mehra (1990)), the levels of the real yield curve and expected consumption growth are higher at (ex post) cycle peaks than at (ex post) troughs. (3) The co-movements of the actual data are broadly consistent with the properties of a simple, trend-stationary real business cycle model where cycle turning points are inherently unpredictable