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

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Author Info
Beechey, Meredith () (Department of Economics, University of California, Berkeley)

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

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Find related papers by JEL classification:
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. 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 2008-39, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  2. Melecky, Martin & Rodrıguez Palenzuela, Diego & Soderstrom, Ulf, 2008. "Inflation Target Transparency and the Macroeconomy," MPRA Paper 10545, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  3. Bergman, Mats A., 2005. "A Welfare Ranking of Two-Sided Market Regimes," Working Paper Series 185, Sveriges Riksbank (Central Bank of Sweden), revised 01 Sep 2005. [Downloadable!]
  4. Monika Piazzesi & Martin Schneider, 2006. "Equilibrium Yield Curves," NBER Working Papers 12609, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Troy Davig & Jeffrey R. Gerlach, 2006. "Monetary Policy, the Bond Market, and Changes in FOMC Communication Policy," Working Papers 31, Department of Economics, College of William and Mary. [Downloadable!]
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