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Excess Sensitivity and Volatility of Long Interest Rates: The Role of Limited Information in Bond Markets

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  • Beechey, Meredith

    ()
    (Department of Economics, University of California, Berkeley)

Abstract

Asymmetric information between the central bank and bond markets creates an inference problem that affects the behaviour of long interest rates. This paper employs a simple macroeconomic model with a time-varying infation target to illustrate the implications of asymmetry for the sensitivity of long rates and volatility of bond returns. When the central bank's infation target is not communicated and macroeconomic shocks are imperfectly observed, bond markets infer the value of the target from noisy signals. This heightens the sensitivity of long-run infation expectations to transitory shocks, thereby raising the measured reaction of long rates to monetary policy and to infation surprises. Calibrated coe±cients from such regressions are more than twice as large when bond markets lack knowledge of the target compared with a full information scenario. Time variation in the infation target is the main source of volatility, but learning adds to the ability of the model to explain the observed volatility of returns along the yield curve.

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Bibliographic Info

Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 173.

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Length: 53 pages
Date of creation: 01 Dec 2004
Date of revision:
Handle: RePEc:hhs:rbnkwp:0173

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Keywords: Term structure of interest rates; yield curve; limited information; learning; excess sensitivity; excess volatility.;

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Cited by:
  1. Bergman, Mats A., 2005. "A Welfare Ranking of Two-Sided Market Regimes," Working Paper Series, Sveriges Riksbank (Central Bank of Sweden) 185, Sveriges Riksbank (Central Bank of Sweden), revised 01 Sep 2005.
  2. Meredith J. Beechey & Jonathan H. Wright, 2008. "The high-frequency impact of news on long-term yields and forward rates: Is it real?," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2008-39, Board of Governors of the Federal Reserve System (U.S.).
  3. Jonsson, Thomas & Österholm, Pär, 2009. "The Properties of Survey-Based Inflation Expectations in Sweden," Working Paper, National Institute of Economic Research 114, National Institute of Economic Research.
  4. Monika Piazzesi & Martin Schneider, 2007. "Equilibrium Yield Curves," NBER Chapters, National Bureau of Economic Research, Inc, in: NBER Macroeconomics Annual 2006, Volume 21, pages 389-472 National Bureau of Economic Research, Inc.
  5. Melecky, Martin & Rodrıguez Palenzuela, Diego & Soderstrom, Ulf, 2008. "Inflation Target Transparency and the Macroeconomy," MPRA Paper 10545, University Library of Munich, Germany.
  6. Troy Davig & Jeffrey R. Gerlach, 2006. "Monetary Policy, the Bond Market, and Changes in FOMC Communication Policy," Working Papers, Department of Economics, College of William and Mary 31, Department of Economics, College of William and Mary.
  7. Queijo von Heideken, Virginia, 2008. "Monetary Policy Regimes and the Volatility of Long-Term Interest Rates," Working Paper Series, Sveriges Riksbank (Central Bank of Sweden) 220, Sveriges Riksbank (Central Bank of Sweden).

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