Inflation Bets on the Long Bond

Review of Financial Studies, Volume 30, Issue 3, 1 March 2017

85 Pages Posted: 14 Jul 2014 Last revised: 6 May 2018

See all articles by Harrison G. Hong

Harrison G. Hong

Columbia University, Graduate School of Arts and Sciences, Department of Economics; National Bureau of Economic Research (NBER)

David Alexandre Sraer

University of California, Berkeley; Princeton University

Jialin Yu

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Date Written: July 19, 2016

Abstract

The liquidity premium theory of interest rates predicts that the Treasury yield curve steepens with inflation uncertainty as investors demand larger risk premia to hold long-term bonds. Using the dispersion of inflation forecasts to measure this uncertainty, we find the opposite. Since the prices of long-term bonds move more with inflation than short-term ones, investors also disagree and speculate more about long-maturity payoffs with greater uncertainty. Shorting frictions, measured using Treasury lending fees, then lead long maturities to become over-priced and the yield curve to flatten. We estimate this inflation-betting effect using time variation in inflation disagreement and Treasury supply.

Keywords: Bond Prices, Term Structure of Interest Rates, Shorting Frictions, Lending Fees, Speculation, Disagreement

JEL Classification: G11, G12

Suggested Citation

Hong, Harrison G. and Sraer, David Alexandre and Yu, Jialin, Inflation Bets on the Long Bond (July 19, 2016). Review of Financial Studies, Volume 30, Issue 3, 1 March 2017. Available at SSRN: https://ssrn.com/abstract=2465451 or http://dx.doi.org/10.2139/ssrn.2465451

Harrison G. Hong (Contact Author)

Columbia University, Graduate School of Arts and Sciences, Department of Economics ( email )

420 W. 118th Street
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

David Alexandre Sraer

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

Princeton University ( email )

22 Chambers Street
Princeton, NJ 08544-0708
United States

Jialin Yu

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong

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