Long run forward rates and long yields of bonds and options in heterogeneous equilibria (Q928503)

The author studies long run zero coupon bond yields and forward rates in heterogeneous, complete market economics. It turns out that in equilibrium, long run forward rates and long yields on bonds reflect the price of long run economic risks and, for this reason, help in understanding of the role of these risks. At first, the yield of a long maturity call option, that is, the per-period return on holding the option up to maturity, is studied. It is proved that in heterogeneous economy with scale-invariant utilities, the yield of a long term bond is determined by the agent with maximal expected marginal utility, and the same is true for the long term forward rates. Then, the limit of the option yield as the maturity tends to infinity, is explicitly calculated with the help of Cramér's large deviation theorem. Several surprising phenomena arise. For example, there is a threshold risk aversion such that the long run option yield is independent of the risk aversion when the latter is above the threshold. Also, the option yield is always greater than or equal to the corresponding equity return.