67 Pages Posted: 17 Jul 2011 Last revised: 4 Jan 2017
Date Written: July 1, 2016
We study the bond markets implications of a heterogeneous economy with low risk aversion agents who use different models to interpret economic shocks. We show analytically that the interaction of low risk aversion and differences in beliefs gives rise to speculative motives for trading that help rationalise several features of Treasury bond markets that traditional models find difficult to explain. Empirically, we test model predictions using a large dataset on beliefs about fundamentals and find that disagreement (i) lowers the unconditional risk-free rate and makes its dynamics pro-cyclical, (ii) raises the slope of the yield curve, and (iii) increase 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
By Andrew Ang