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Ambiguity, Nominal Bond Yields, and Real Bond Yields†

Ambiguity, Nominal Bond Yields, and Real Bond Yields† AbstractThis paper presents an equilibrium bond-pricing model that jointly explains the upward-sloping nominal and real yield curves and the violation of the expectations hypothesis. Instead of relying on the inflation risk premium, the ambiguity-averse agent faces different amounts of Knightian uncertainty in the long run versus the short run; hence, the model-implied nominal and real short rate expectations are upward sloping under the agent’s worst-case equilibrium beliefs. The expectations hypothesis roughly holds under investors’ worst-case beliefs. The difference between the worst-case scenario and the true distribution makes realized excess returns on long-term bonds predictable. (JEL D81, D84, E23, E31, E43, E44, G12) http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Review: Insights American Economic Association

Ambiguity, Nominal Bond Yields, and Real Bond Yields†

American Economic Review: Insights , Volume 2 (2) – Jun 1, 2020

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Publisher
American Economic Association
Copyright
Copyright © 2020 © American Economic Association
ISSN
2640-205X
eISSN
2640-2068
DOI
10.1257/aeri.20190155
Publisher site
See Article on Publisher Site

Abstract

AbstractThis paper presents an equilibrium bond-pricing model that jointly explains the upward-sloping nominal and real yield curves and the violation of the expectations hypothesis. Instead of relying on the inflation risk premium, the ambiguity-averse agent faces different amounts of Knightian uncertainty in the long run versus the short run; hence, the model-implied nominal and real short rate expectations are upward sloping under the agent’s worst-case equilibrium beliefs. The expectations hypothesis roughly holds under investors’ worst-case beliefs. The difference between the worst-case scenario and the true distribution makes realized excess returns on long-term bonds predictable. (JEL D81, D84, E23, E31, E43, E44, G12)

Journal

American Economic Review: InsightsAmerican Economic Association

Published: Jun 1, 2020

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