Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates

33 Pages Posted: 21 Jul 2020 Last revised: 13 Aug 2021

See all articles by Shuo Cao

Shuo Cao

Shenzhen Stock Exchange; City University of Hong Kong (CityU)

Richard K. Crump

Federal Reserve Banks - Federal Reserve Bank of New York

Stefano Eusepi

University of Texas at Austin

Emanuel Moench

Frankfurt School of Finance and Management

Multiple version iconThere are 2 versions of this paper

Date Written: July 1, 2020

Abstract

Using a unique data set of individual professional forecasts, we document disagreement about the future path of monetary policy, particularly at longer horizons. The stark differences in short rate forecasts imply strong disagreement about the risk-return trade-off of longer-term bonds. Longer-horizon short rate disagreement co-moves with term premiums. We estimate an affine term structure model in which investors hold heterogeneous beliefs about the long-run level of rates. Our model fits Treasury yields and the short rate paths predicted by different groups of investors and thus matches the observed differences in expected return profiles. Investors who correctly anticipated the secular decline in rates became increasingly important for the marginal pricing of risk in the Treasury market. Accounting for heterogeneity in investment performance eliminates the downward trend in the term premium.

Keywords: disagreement, heterogeneous beliefs, noisy information, speculation, survey forecasts, yield curve, term premium

JEL Classification: D83, D84, E43, G10, G12

Suggested Citation

Cao, Shuo and Crump, Richard K. and Eusepi, Stefano and Moench, Emanuel, Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates (July 1, 2020). Available at SSRN: https://ssrn.com/abstract=3654384 or http://dx.doi.org/10.2139/ssrn.3654384

Shuo Cao

Shenzhen Stock Exchange ( email )

2012 Shennan Blvd., Futian District
Shenzhen
China

City University of Hong Kong (CityU) ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

Richard K. Crump (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Stefano Eusepi

University of Texas at Austin ( email )

2317 Speedway
Austin, TX 78712
United States

Emanuel Moench

Frankfurt School of Finance and Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

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