Government guarantee, inflation-linked bonds, and investment with ambiguity and learning
The broad aim of this dissertation is to explain some puzzling phenomena in Finance and Macroeconomics, focusing on the role of (1) government guarantee, (2) Inflation-Linked Bonds (ILBs) and (3) models with ambiguity and learning. I explore their quantitative and qualitative influences on consumption, investment and financing decisions. The first chapter analyzes the effect of government guarantee cost as a new incentive to issue ILBs. During a political decision or reform process, a government typically has to provide some form of compensation to avoid noncompliance. The cost of this guarantee could be significant, and issuing ILBs instead of providing this guarantee would be a way for the government to avoid this cost. The model with this new feature provides a mechanism to explain why some countries issue ILBs with low inflation and also justifies why countries typically only issue small amounts of ILBs compared to nominal bonds, neither of which practices is well explained by the previous literature. The second chapter introduces ambiguity and learning into a portfolio-choice model to explain some puzzling stylized facts, especially the "hump-shaped" share in risky asset in relation to age. I find that the ambiguity over labor income will make the agent not invest much in risky assets at the beginning of the working life. As the agent approaches retirement, there are two partially offsetting effects. First, the learning mechanism gradually solves the uncertainty. Second, the value of the bond position implicit in his human capital decreases. Eventually, this second effect prevails, and hence explains the hump-shaped stock allocation of the agent's life-cycle profile. The third chapter discusses the role of ILBs in China's pension reform. Firstly it reviews the current problems of China's pension structure so as to find ways to improve the conditions of Chinese pensioners. In particular, I argue that the government could issue ILBs. Then by conducting a simulation using China's macro and financial data, I show that the ILBs will provide the investor with a significantly better risk-return trade-off.