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Speculative Dynamics in the Term Structure of Interest Rates

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  • Kristoffer Nimark

Abstract

When long maturity bonds are traded frequently and traders have non-nested information sets, speculative behavior in the sense of Harrison and Kreps (1978) arises. Using a term structure model displaying such speculative behavior, this paper proposes a conceptually and observationally distinct new mechanism generating time varying predictable excess returns. It is demonstrated that (i) dispersion of expectations about future short rates is sufficient for individual traders to systematically predict excess returns and (ii) the new term structure dynamics driven by speculative trade is orthogonal to public information in real time, but (iii) can nevertheless be quantified using only publicly available yield data. The model is estimated using monthly data on US short to medium term Treasuries from 1964 to 2007 and it provides a good t of the data. Speculative dynamics are found to be quantitatively important, potentially accounting for a substantial fraction of the variation of bond yields and appears to be more important at long maturities.

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 430.

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Date of creation: Aug 2012
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Handle: RePEc:bge:wpaper:430

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Keywords: term structure of interest rates; speculative dynamics; Eexcess returns; nonnested;

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Cited by:
  1. Badarinza, Cristian & Buchmann, Marco, 2011. "Macroeconomic vulnerability and disagreement in expectations," Working Paper Series, European Central Bank 1407, European Central Bank.
  2. Francisco Barillas & Kristoffer Nimark, 2012. "Speculation, risk premia and expectations in the yield curve," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 1337, Department of Economics and Business, Universitat Pompeu Fabra, revised Nov 2013.
  3. Hatchondo, Juan Carlos & Krusell, Per & Schneider, Martin, 2014. "Asset Trading and Valuation with Uncertain Exposure," Working Paper, Federal Reserve Bank of Richmond 14-5, Federal Reserve Bank of Richmond.
  4. Andrade, Philippe & Crump, Richard K. & Eusepi, Stefano & Moench, Emanuel, 2013. "Noisy information and fundamental disagreement," Staff Reports, Federal Reserve Bank of New York 655, Federal Reserve Bank of New York.

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