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Heterogeneous Expectations and Bond Markets

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  • Wei Xiong
  • Hongjun Yan
  • Review Financial

Abstract

This paper presents a dynamic equilibrium model of bond markets in which two groups of agents hold heterogeneous expectations about future economic conditions. The heterogeneous expectations cause agents to take speculative positions against each other and therefore generate endogenous relative wealth fluctuation. The relative wealth fluctuation amplifies asset price volatility and contributes to the time variation in bond premia. Our model shows that a modest amount of heterogeneous expectation can help explain several puzzling phenomena, including the "excessive volatility" of bond yields, the failure of the expectations hypothesis, and the ability of a tent-shaped linear combination of forward rates to predict bond returns.

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File URL: http://icfpub.som.yale.edu/publications/2614
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Bibliographic Info

Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number amz2614.

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Date of creation: 01 Jan 2007
Date of revision: 01 Jun 2009
Handle: RePEc:ysm:somwrk:amz2614

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Web page: http://icf.som.yale.edu/
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Keywords: bond markets; heterogeneous expectations; yield curve; bond yield volatility Accepted Paper Series;

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Citations

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Cited by:
  1. Ingrid Lo & Stephen Sapp, 2011. "Belief Dispersion and Order Submission Strategies in the Foreign Exchange Market," Working Papers 11-8, Bank of Canada.
  2. Hongjun Yan, 2008. "Is Noise Trading Cancelled Out by Aggregation?," Yale School of Management Working Papers amz2604, Yale School of Management, revised 01 Jan 2009.
  3. Leonid Kogan & Stephen Ross & Jiang Wang & Mark M. Westerfield, 2009. "Market Selection," NBER Working Papers 15189, National Bureau of Economic Research, Inc.
  4. Hong, Harrison & Sraer, David, 2013. "Quiet bubbles," Journal of Financial Economics, Elsevier, vol. 110(3), pages 596-606.
  5. Xavier Gabaix, 2012. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in Macro-Finance," The Quarterly Journal of Economics, Oxford University Press, vol. 127(2), pages 645-700.
  6. Jianfeng Yu, 2011. "A sentiment-based explanation of the forward premium puzzle," Globalization and Monetary Policy Institute Working Paper 90, Federal Reserve Bank of Dallas.
  7. Christensen, Peter Ove & Larsen, Kasper & Munk, Claus, 2012. "Equilibrium in securities markets with heterogeneous investors and unspanned income risk," Journal of Economic Theory, Elsevier, vol. 147(3), pages 1035-1063.
  8. Dan Cao, 2011. "Collateral Shortages, Asset Price and Investment Volatility with Heterogeneous Beliefs," Working Papers gueconwpa~11-11-01, Georgetown University, Department of Economics.
  9. Wei Xiong, 2013. "Bubbles, Crises, and Heterogeneous Beliefs," NBER Working Papers 18905, National Bureau of Economic Research, Inc.
  10. Roman Muraviev, 2013. "Market selection with learning and catching up with the Joneses," Finance and Stochastics, Springer, vol. 17(2), pages 273-304, April.
  11. Yu, Jianfeng, 2013. "A sentiment-based explanation of the forward premium puzzle," Journal of Monetary Economics, Elsevier, vol. 60(4), pages 474-491.
  12. Jaksa CVITANIC & Semyon MALAMUD, 2010. "Price Impact and Portfolio Impact," Swiss Finance Institute Research Paper Series 10-26, Swiss Finance Institute.
  13. Sekkel, Rodrigo, 2011. "International evidence on bond risk premia," Journal of Banking & Finance, Elsevier, vol. 35(1), pages 174-181, January.
  14. Aytek Malkhozov & Philippe Mueller & Andrea Vedolin & Gyuri Venter, 2013. "Mortgage Hedging in Fixed Income Markets," FMG Discussion Papers dp722, Financial Markets Group.
  15. Ming Pu & Gang-Zhi Fan & Seow Ong, 2012. "Heterogeneous Agents and the Indifference Pricing of Property Index Linked Swaps," The Journal of Real Estate Finance and Economics, Springer, vol. 44(4), pages 543-569, May.
  16. Philippe Mueller & Andrea Vedolin & Hao Zhou, 2011. "Short Run Bond Risk Premia," FMG Discussion Papers dp686, Financial Markets Group.
  17. Robert Edelstein & Peng Liu & Fang Wu, 2012. "The Market for Real Estate Presales: A Theoretical Approach," The Journal of Real Estate Finance and Economics, Springer, vol. 45(1), pages 30-48, June.

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