Maturity Increasing Overreaction and Bond Market Puzzles

93 Pages Posted: 7 Dec 2020

See all articles by Daniele d'Arienzo

Daniele d'Arienzo

Bocconi University - Department of Finance

Date Written: November 18, 2020


Long-term treasury yields are known to be (i) excessively volatile (Giglio and Kelly, 2018), (ii) highly sensitive to short-rate movements (Hanson et al., 2018), and (iii) highly predictable from non-priced factors (Duffee, 2013). I assess the possibility that these puzzles may be due to non-rational investor beliefs. Using survey data as well as market beliefs recovered from bond yields, I document that expectations about long rates overreact to news, relative to expectations about short rates. I show that introducing diagnostic expectations into an affine term-structure model yields such maturity increasing overreaction and reconciles the three puzzles. When benchmarked against external estimates of diagnostic distortions, this model accounts for (i) 80% of the excess volatility, (ii) 40% of the excess sensitivity of long rates, and (iii) excess-bond-returns predictability coming from past forecast revisions.

Keywords: Affine Term-Structure Models, Diagnostic Expectations, Excess volatility, Overreaction

Suggested Citation

d'Arienzo, Daniele, Maturity Increasing Overreaction and Bond Market Puzzles (November 18, 2020). Available at SSRN: or

Daniele D'Arienzo (Contact Author)

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136

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