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Speculation, risk premia and expectations in the yield curve

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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 Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1337.

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Date of creation: Aug 2012
Date of revision: Nov 2013
Handle: RePEc:upf:upfgen:1337

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Web page: http://www.econ.upf.edu/

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Keywords: speculation; risk premia; yield curve;

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  1. James D. Hamilton & Jing Cynthia Wu, 2012. "Identification and Estimation of Gaussian Affine Term Structure Models," NBER Working Papers 17772, National Bureau of Economic Research, Inc.
  2. Andrea Buraschi & Alexei Jiltsov, 2006. "Model Uncertainty and Option Markets with Heterogeneous Beliefs," Journal of Finance, American Finance Association, vol. 61(6), pages 2841-2897, December.
  3. Philippe Mueller & Mikhail Chernov, 2008. "The Term Structure of Inflation Expectations," 2008 Meeting Papers 346, Society for Economic Dynamics.
  4. Philippe Bacchetta & Elmar Mertens & Eric van Wincoop, 2006. "Predictability in Financial Markets: What Do Survey Expectations Tell Us?," Working Papers 06.04, Swiss National Bank, Study Center Gerzensee.
  5. Swanson, Eric T., 2006. "Have Increases in Federal Reserve Transparency Improved Private Sector Interest Rate Forecasts?," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(3), pages 791-819, April.
  6. Kristoffer Nimark, 2009. "Speculative dynamics in the term structure of interest rates," Economics Working Papers 1194, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 2012.
  7. Albert Lee Chun, 2011. "Expectations, Bond Yields, and Monetary Policy," Review of Financial Studies, Society for Financial Studies, vol. 24(1), pages 208-247.
  8. Kristoffer Nimark, 2007. "Dynamic Higher Order Expectations," 2007 Meeting Papers 542, Society for Economic Dynamics.
  9. Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 546-88, August.
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