Heterogeneous expectations and bond markets

Wei Xiong, Hongjun Yan

Research output: Contribution to journalArticle

74 Scopus citations

Abstract

This paper presents a dynamic equilibrium model of bond markets in which two groups of agents hold heterogeneous expectations about future economic conditions. The heterogeneous expectations cause agents to take on speculative positions against each other and therefore generate endogenous relative wealth fluctuation. The relative wealth fluctuation amplifies asset price volatility and contributes to the time variation in bond premia. Our model shows that a modest amount of heterogeneous expectations can help explain several puzzling phenomena, including the "excessive volatility" of bond yields, the failure of the expectations hypothesis, and the ability of a tent-shaped linear combination of forward rates to predict bond returns.

Original languageEnglish (US)
Pages (from-to)1433-1466
Number of pages34
JournalReview of Financial Studies
Volume23
Issue number4
DOIs
StatePublished - Apr 2010

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics

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