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Speculation, Risk Premia and Expectations in the Yield Curve

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  • Francisco Barillas
  • Kristoffer Nimark

Abstract

An affine asset pricing model in which agents have rational but heterogeneous expectations about future asset prices is developed. We estimate the model using data on bond yields and individual survey responses from the Survey of Professional Forecasters and perform a novel three-way decomposition of bond yields into (i) average expectations about short rates (ii) risk premia and (iii) a speculative component due to heterogeneous expectations about the resale value of a bond. We prove that the speculative term must be orthogonal to public information in real time and therefore statistically distinct from risk premia. Empirically, the speculative component is quantitatively important, accounting for up to one percentage point of US yields. Furthermore, estimates of historical risk premia from the heterogeneous information model are less volatile than, and negatively correlated with, risk premia estimated using a standard Affine Gaussian Term Structure model.

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Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 659.

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Date of creation: Nov 2013
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Handle: RePEc:bge:wpaper:659

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Keywords: speculation; risk premia; yield curve;

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  1. Bacchetta, Philippe & Mertens, Elmar & van Wincoop, Eric, 2006. "Predictability in Financial Markets: What Do Survey Expectations Tell Us?," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5770, C.E.P.R. Discussion Papers.
  2. Kristoffer Nimark, 2012. "Speculative Dynamics in the Term Structure of Interest Rates," Working Papers, Barcelona Graduate School of Economics 430, Barcelona Graduate School of Economics.
  3. Albert Lee Chun, 2011. "Expectations, Bond Yields, and Monetary Policy," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 24(1), pages 208-247.
  4. Kristoffer Nimark, 2007. "Dynamic higher order expectations," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 1118, Department of Economics and Business, Universitat Pompeu Fabra, revised Mar 2011.
  5. Hamilton, James D. & Wu, Jing Cynthia, 2012. "Identification and estimation of Gaussian affine term structure models," Journal of Econometrics, Elsevier, Elsevier, vol. 168(2), pages 315-331.
  6. Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 91(4), pages 546-88, August.
  7. Philippe Mueller & Mikhail Chernov, 2008. "The Term Structure of Inflation Expectations," 2008 Meeting Papers 346, Society for Economic Dynamics.
  8. Andrea Buraschi & Alexei Jiltsov, 2006. "Model Uncertainty and Option Markets with Heterogeneous Beliefs," Journal of Finance, American Finance Association, American Finance Association, vol. 61(6), pages 2841-2897, December.
  9. Swanson, Eric T., 2006. "Have Increases in Federal Reserve Transparency Improved Private Sector Interest Rate Forecasts?," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 38(3), pages 791-819, April.
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