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The Quality of Public Information and The Term Structure of Interest Rates

  • Frederik Lundtofte

    (Swiss Institute of Banking and Finance, University of St-Gallen)

This paper analyzes the term structure of interest rates in an exchangeonly Lucas (1978) economy where consumers learn about a stochastic growth rate through observations of the endowment process and an external public signal. We show that there is a premium for noisy external public information in long-term bonds. In contrast to Feldman (1989), where agents learn only through realized outputs, we find that nonstochastic interest rates are not necessary for the expectations hypothesis to hold.

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Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 06-24.

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Length: 27 pages
Date of creation: Feb 2006
Date of revision: Sep 2006
Handle: RePEc:chf:rpseri:rp0624
Contact details of provider: Web page: http://www.SwissFinanceInstitute.ch

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  1. Darrell Duffie & Rui Kan, 1996. "A Yield-Factor Model Of Interest Rates," Mathematical Finance, Wiley Blackwell, vol. 6(4), pages 379-406.
  2. Feldman, David, 1992. "Logarithmic Preferences, Myopic Decisions, and Incomplete Information," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 27(04), pages 619-629, December.
  3. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1981. "A Re-examination of Traditional Hypotheses about the Term Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 36(4), pages 769-99, September.
  4. Wachter, Jessica A., 2006. "A consumption-based model of the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 79(2), pages 365-399, February.
  5. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-84, March.
  6. N. Gregory Mankiw, 1986. "The Term Structure of Interest Rates Revisited," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 17(1), pages 61-110.
  7. de Jong, Frank, 1999. "Time-series and Cross-section Information in Affine Term Structure Models," CEPR Discussion Papers 2065, C.E.P.R. Discussion Papers.
  8. Detemple, Jerome B, 1986. " Asset Pricing in a Production Economy with Incomplete Information," Journal of Finance, American Finance Association, vol. 41(2), pages 383-91, June.
  9. Lundtofte, Frederik, 2008. "Expected life-time utility and hedging demands in a partially observable economy," European Economic Review, Elsevier, vol. 52(6), pages 1072-1096, August.
  10. Dothan, Michael U & Feldman, David, 1986. " Equilibrium Interest Rates and Multiperiod Bonds in a Partially Observable Economy," Journal of Finance, American Finance Association, vol. 41(2), pages 369-82, June.
  11. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  12. Williams, Joseph T., 1977. "Capital asset prices with heterogeneous beliefs," Journal of Financial Economics, Elsevier, vol. 5(2), pages 219-239, November.
  13. Dumas, Bernard J & Kurshev, Alexander & Uppal, Raman, 2007. "Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility," CEPR Discussion Papers 6455, C.E.P.R. Discussion Papers.
  14. Pietro Veronesi, 2000. "How Does Information Quality Affect Stock Returns?," Journal of Finance, American Finance Association, vol. 55(2), pages 807-837, 04.
  15. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
  16. Monika Piazzesi & Martin Schneider, 2007. "Equilibrium Yield Curves," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 389-472 National Bureau of Economic Research, Inc.
  17. Hirshleifer, Jack, 1971. "The Private and Social Value of Information and the Reward to Inventive Activity," American Economic Review, American Economic Association, vol. 61(4), pages 561-74, September.
  18. Feldman, David, 1989. " The Term Structure of Interest Rates in a Partially Observable Econom y," Journal of Finance, American Finance Association, vol. 44(3), pages 789-812, July.
  19. Qiang Dai & Kenneth J. Singleton, 2000. "Specification Analysis of Affine Term Structure Models," Journal of Finance, American Finance Association, vol. 55(5), pages 1943-1978, October.
  20. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
  21. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  22. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-92, September.
  23. Bruce Mizrach & Filippo Occhino, 2004. "The Impact of Monetary Policy on Bond Returns Volatility: A Segmented Markets Approach," Departmental Working Papers 200402, Rutgers University, Department of Economics.
  24. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March.
  25. Li, George, 2005. "Information Quality, Learning, and Stock Market Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(03), pages 595-620, September.
  26. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
  27. Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, vol. 1(3), pages 225-244, September.
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