Real and nominal interest rates: a discrete-time moel and its continuous-time limit

I provide a general equilibrium theory of the term structureof real interest rates in a discrete-time economy. I derivethe prices for one-perid and two-period real bonds and a simplerecursive formula for general k-period bonds, and prove thatthe price formula with appropriately specified parameters conversesto that of the Cox, Ingersoll, and Ross model (1985). In addition,I consider the behavior of nominal bond pries in a partial equilibriumsetting in which an exogenous price level process is correlatedwith the real economy. Finally, I provide an illustrative empiricalinvestigation of the model. The results indicate a significantcorrelation between the price level and the growth rate of consumption,which does not support the 'money neutrality' assumption underlyingCox, Ingersoll and Ross's nominal bond prices and related empiricalstudies, such as Gibbons and Ramaswamy (1992), Heston (1991),and Pearson and Sun (1991).