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Short vs. Long Term Bonds: (s15q1) Suppose that there are three types of assets in an economy with infinitely lived households: money, Mt, a one-period
Short vs. Long Term Bonds: (s15q1) Suppose that there are three types of assets in an economy with infinitely lived households: money, Mt, a one-period bond, Bt1, that pays off $1 in period t+1 and sold at Pt1 in period t, and a two-period bond, Bt2, which pays off $1 in period t+2 and sold at Pt2 in period t. Assume that there is a secondary market in period t where the representative household can sell a two-period bond purchased in period t1 and matures in period t+1. Note that it is equivalent to a one-period bond. So, its price is Pt1. Further assume that the instantaneous utility function of the representative household has the log form over the consumption good and real money balances: u(ct,PtMt)=log(ct)+log(PtMt), where Pt is the price of the consumption good in period t. Assume that the individual discounts at
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