Speculation, Sentiment, and Interest Rates
57 Pages Posted: 17 Jul 2011 Last revised: 2 Nov 2018
Date Written: February 1, 2018
We compare bond markets implications of speculation versus hedging channels in heterogeneous agents economies. Treasuries command a significant risk premium when optimistic agents speculate by leveraging their positions using bond markets. Disagreement drives a wedge between marginal agent vs. econometrician beliefs (sentiment). When speculative demands dominate, the interaction between belief heterogeneity and sentiment helps rationalize several puzzling characteristics of Treasury markets. Empirically, we test model predictions and find that larger disagreement (i) lowers the unconditional risk-free rate, (ii) raises the slope of the yield curve; and (iii) with positive sentiment increases bond risk premia and makes its dynamics counter-cyclical.
Keywords: Fixed income, Bond Risk Premia, Heterogeneous Agents, Speculation
JEL Classification: D9, E3, E4, G12
Suggested Citation: Suggested Citation