Macroeconomic Belief Distortions in Bond Returns

Abstract

This paper provides an economic belief indicator by combining a data-rich environment with a machine learning method and documents that it corrects errors in survey-based macroeconomic expectations, monetary policy expectations, and subjective interest rate forecasts. We show that macroeconomic belief distortions induce ex post predictability of excess bond returns. We further test the belief-based spanning hypothesis and …nd that the belief indicator's predictive power is unspanned by interest rate expectation errors and other yield-curve or macro factors, suggesting that macroeconomic belief distortions account for bond return predictability in addition to interest rate expectation errors and time-varying risk premium.

Keywords: JEL Classi…cations: G1, E4 Belief Distortions, Bond Returns, Rational Expectations, Spanning Hypothesis, Subjective Interest Rates