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Misaligned expectations and bond term premium measures

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  • Vázquez, Jesús

Abstract

This paper shows that inflation expectations and those embedded in short-term interest rate expectations as reported in the Survey of Professional Forecasters show evidence of misaligned expectations. This misalignment seems to have been substantial in recent times, featuring a low correlation between inflation and the policy rate. This empirical evidence motivates an alternative explanation, based on uncertainty rather than risk, of the bond term premium measures found in the literature. This paper estimates an expectational term premium driven by misaligned short-term interest rate expectations from a behavioral DSGE model that introduces model uncertainty by assuming adaptive learning with discretionary beliefs. The estimated 10-year expectational term premium shares important features with the corresponding term premium measures obtained using no-arbitrage affine term structure models. Thus, the expectational term premium is sizable, highly persistent, mildly countercyclical, and highly correlated with those term premium measures in the most recent period studied. In short, a potential misalignment of short-term interest expectations with inflation expectations provides an important channel for explaining the bond premium lately.

Suggested Citation

  • Vázquez, Jesús, 2025. "Misaligned expectations and bond term premium measures," The North American Journal of Economics and Finance, Elsevier, vol. 79(C).
    • Handle: RePEc:eee:ecofin:v:79:y:2025:i:c:s1062940825000828
    DOI: 10.1016/j.najef.2025.102442
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    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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