DP9755 Speculation, Risk Premia and Expectations in the Yield Curve

Author(s): Francisco Barillas, Kristoffer P Nimark
Publication Date: November 2013
Keyword(s): Heterogenous information, Speculation, Survey data, Term structure of interest rates
JEL(s): G12, G14
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9755

An affine asset pricing model in which agents have rational but heterogeneous expectations about future asset prices is developed. We estimate the model using data on bond yields and individual survey responses from the Survey of Professional Forecasters and perform a novel three-way decomposition of bond yields into (i) average expectations about short rates (ii) risk premia and (iii) a speculative component due to heterogeneous expectations about the resale value of a bond. We prove that the speculative term must be orthogonal to public information in real time and therefore statistically distinct from risk premia. Empirically, the speculative component is quantitatively important, accounting for up to one percentage point of US yields. Furthermore, estimates of historical risk premia from the heterogeneous information model are less volatile than, and negatively correlated with, risk premia estimated using a standard Affine Gaussian Term Structure model.