Speculation, Hedging, and Interest Rates
The University of Chicago; Imperial College Business School; Centre for Economic Policy Research (CEPR)
Copenhagen Business School
January 1, 2016
We study the properties of bonds in an economy with risk tolerant agents who are rationally induced to trade because they believe in different models for the dynamics of the economy. We show analytically that low risk aversion coupled with differences in beliefs can help rationalise several features of Treasury bond markets that the single agent paradigm finds difficult to reconcile. Empirically, we test predictions from the model using a large dataset on beliefs about fundamentals and find that: (i) shocks to disagreement lower short term interest rates; (ii) raise the slope of the yield curve; and (iii) predict expected excess bond returns.
Number of Pages in PDF File: 56
Keywords: Fixed income, Bond Risk Premia, Heterogeneous Agents, Speculation
JEL Classification: D9, E3, E4, G12
Date posted: July 17, 2011 ; Last revised: February 8, 2016
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