We propose a consumption-based model that allows for an inverted term structure of real and nominal risk-free rates.
In our framework the agent is subject to time-varying macroeconomic risk, and interest rates at all maturities depend on her risk perception, which shapes saving propensities over time.
In bad times, when risk is perceived to be higher in the short- than in the long-term, the agent would prefer to hedge against low realizations of consumption in the near future by investing in long-term securities.
In equilibrium, this leads to the inversion of the yield curve. Pricing time-varying consumption volatility risk is essential in order to obtain the inversion of the real curve and allows the average level and the slope of the nominal level to be priced.
