Monetary Policy and Bond Prices with Drifting Equilibrium Rates

Journal of Financial and Quantitative Analysis

55 Pages Posted: 15 Oct 2020 Last revised: 19 Oct 2022

See all articles by Carlo A. Favero

Carlo A. Favero

Bocconi University - Department of Economics; Bocconi University - Department of Finance; Centre for Economic Policy Research (CEPR)

Alessandro Melone

Ohio State University (OSU) - Fisher College of Business

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Multiple version iconThere are 2 versions of this paper

Date Written: October 4, 2020

Abstract

We study the drift and cyclical components in U.S. Treasury bonds. We find that bond yields are drifting because they reflect the drift in monetary policy rates.
Empirically, modeling the monetary policy drift using demographics and productivity trends, plus long-term inflation expectations, leads to cyclical deviations of bond prices from their drift that predict bond returns in- and out-of-sample.
These bond cycles can be interpreted as term premia or/and temporary deviations from rational expectations in a behavioral framework. Through the lens of our model, we detect a significant role of the latter in determining the cyclical properties of yields with short maturities.

Keywords: Monetary Policy Rule, Secular Trends, Term Structure, Diagnostic Expectations, Bond Return Predictability

JEL Classification: E43, E52, G12

Suggested Citation

Favero, Carlo A. and Melone, Alessandro and Tamoni, Andrea, Monetary Policy and Bond Prices with Drifting Equilibrium Rates (October 4, 2020). Journal of Financial and Quantitative Analysis, Available at SSRN: https://ssrn.com/abstract=3704241 or http://dx.doi.org/10.2139/ssrn.3704241

Carlo A. Favero (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

HOME PAGE: http://www.igier.unibocconi.it\favero

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Alessandro Melone

Ohio State University (OSU) - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

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