Incomplete Markets and the Yield Curve

We present a general equilibrium model with incomplete markets and borrowing constraints to study the interest rate term structure. Agents face both an aggregate risk and an idiosyncratic risk of unemployment, which is not insurable. We derive analytical expressions for the bond prices, whatever their maturities. We also exhibit the e ects of credit constraints on the whole price structure. The bond supply a ects the yield curve through a wealth e ect. We prove notably that a larger volume of titles shifts the level of the yield curve downward and increases its slope. Finally, credit constraints allow idiosyncratic and aggregate risks to interact and thus make interest rates more volatile.