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Speculation, risk premia and expectations in the yield curve

  • Francisco Barillas
  • Kristoffer Nimark

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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File URL: http://www.econ.upf.edu/docs/papers/downloads/1337.pdf
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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
Contact details of provider: Web page: http://www.econ.upf.edu/

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  1. Philippe Bacchetta & Elmar Mertens & Eric van Wincoop, 2006. "Predictability in Financial Markets: What Do Survey Expectations Tell Us?," Working Papers 102006, Hong Kong Institute for Monetary Research.
  2. Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 546-88, August.
  3. Philippe Mueller & Mikhail Chernov, 2008. "The Term Structure of Inflation Expectations," 2008 Meeting Papers 346, Society for Economic Dynamics.
  4. Albert Lee Chun, 2005. "Expectations, Bond Yields and Monetary Policy," Discussion Papers 04-023, Stanford Institute for Economic Policy Research, revised Nov 2010.
  5. Hamilton, James D. & Wu, Jing Cynthia, 2012. "Identification and estimation of Gaussian affine term structure models," Journal of Econometrics, Elsevier, vol. 168(2), pages 315-331.
  6. Kristoffer Nimark, 2012. "Speculative Dynamics in the Term Structure of Interest Rates," Working Papers 430, Barcelona Graduate School of Economics.
  7. 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.
  8. Kristoffer Nimark, 2007. "Dynamic Higher Order Expectations," 2007 Meeting Papers 542, Society for Economic Dynamics.
  9. 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.
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