Abstract
Bansal and Yaron (2004) show that long-run consumption risks and time-varying economic uncertainty in conjunction with recursive preferences can account for important features of equity markets. I bring the model to the term structure of interest rates and show that a calibrated version of the model can simultaneously explain properties of bonds and equities. Specifically, the model accounts for deviations from the expectations hypothesis, the upward sloping nominal yield curve, and the predictive power of the nominal yield spread. However, an estimation of the model using Simulated Method of Moments yields less convincing results and illustrates the difficulty of precisely estimating parameters of the model. Real (nominal) interest rates in the model are positively (negatively) correlated with consumption growth and real stock returns move inversely with inflation. The cyclicality of nominal interest rates and yield spreads is shown to depend on the relative values of the elasticity of intertemporal substitution and the correlation between real consumption growth and inflation.