Speculation, Sentiment, and Interest Rates

Andrea Buraschi*, Paul Whelan*

*Corresponding author for this work

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Abstract

We compare the implications of speculation versus hedging channels for bond markets in heterogeneous agents’ economies. Treasuries command a significant risk premium when optimistic agents speculate by leveraging their positions using bonds. Disagreement drives a wedge between marginal agent versus econometrician beliefs (sentiment). When speculative demands dominate, the interaction between belief heterogeneity and sentiment helps rationalize several puzzling characteristics of Treasury markets. Empirically, we test model predictions and find that larger disagreement (i) lowers the risk-free rate, (ii) raises the slope of the yield curve, and (iii) with positive sentiment increases bond risk premia and makes its dynamics countercyclical.
Original languageEnglish
JournalManagement Science
Volume68
Issue number3
Pages (from-to)2308-2329
Number of pages22
ISSN0025-1909
DOIs
Publication statusPublished - Mar 2022

Bibliographical note

Published online: April 20, 2021.

Keywords

  • Fixed income
  • Bond risk premia
  • Heterogeneous agents
  • Speculation

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