Abstract
We analyze a dynamic investment problem with interest rate risk and ambiguity. After deriving the optimal terminal wealth and investment policy, we expand our model into a robust general equilibrium model and calibrate it to U.S. data. We confirm the bond premium puzzle, i.e., we need an unreasonably high relative risk-aversion parameter to explain excess returns on long-term bonds. Our model with robust investors reduces this risk-aversion parameter substantially: a relative risk aversion of less than four suffices to match market data. Additionally we provide a novel formulation of robust dynamic investment problems together with an alternative solution technique: the robust version of the martingale method.
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