Subjective Risk Premia in Bond and FX Markets

This paper exploits an international survey dataset on interest rates and exchange rates to argue that, relative to common statistical benchmarks, subjective beliefs appear quite accurate and do not display strong evidence against rational expectations. We use surveys to study the expected return of an economically important investment strategy that buys a foreign long-term bond and sells a long-term U.S bond. Subjective risk premia on this trade are large, time-varying, counter-cyclical, positively correlated with risk proxies and predict future realised returns. Finally, we study implications for the design of structural models by estimating an SDF decomposition into permanent and transitory components.