Paul Whelan

Speculation, Hedging, and Interest Rates

We study the properties of bonds in an economy with risk tolerant agents who are rationally induced to trade because they believe in different models for the dynamics of the economy. We show analytically that low risk aversion coupled with differences in beliefs can help rationalise several features of Treasury bond markets that the single agent paradigm finds difficult to reconcile. Empirically, we test predictions from the model using a large dataset on beliefs about fundamentals and find that: (i) shocks to disagreement lower short term interest rates; (ii) raise the slope of the yield curve; and (iii) predict expected excess bond returns.In this paper we study both theoretically and empirically the implications of macroeconomic disagreement for bond market dynamics. If there is a source of heterogeneity in the belief structure of the economy then differences in beliefs can affect equilibrium asset prices. Using survey data on a unique data set we propose a new empirically observable proxy to measure macroeconomic disagreement and find a number of novel results. First, consistent with a general equilibrium model, heterogeneity in beliefs affect the price of risk so that belief dispersion regarding the real economy, inflation, short and long term interest rates predict excess bond returns with R 2 between 21%43%. Second, macroeconomic disagreement explains the volatility of stock and bonds with high statistical significance with an R 2 ∼ 26% in monthly projections. Third, disagreement also contains significant information trading activity: dispersion in beliefs explains the growth rate of open interest on 10 year treasury notes with R 2 equal to 21%. Fourth, while around half the information contained in the cross-section of expectations is spanned by the yield curve, there remains large unspanned component important for bond pricing. Finally, we control for an array of alternative predictor variables and show that the information contained in the belief structure of the economy is different from either consensus views or fundamentals. JEL classification: D9, E3, E4, G12

Expected Term Structures

This paper studies the properties of bond risk premia in the cross-section of subjective expectations. We exploit an extensive dataset of yield curve forecasts from financial institutions and document a number of novel findings. First, contrary to evidence presented for stock markets but consistent with rational expectations, the relation between subjective expectations and future realizations is positive, and this result holds for the entire cross-section of beliefs. Second, when predicting short term interest rates, primary dealers display superior forecasting ability when compared to non-primary dealers. Third, we reject the null hypothesis that subjective expected bond returns are constant. When predicting long term rates, however, primary dealers have no information advantage. This suggests that a key source of variation in long-term bonds are risk premia and not short-term rate variation. Fourth, we show that consensus beliefs are not a sufficient statistics to describe the cross-section of beliefs. Moreover, the beliefs of the most accurate agents are those most spanned by a contemporaneous cross-section of bond prices. This supports equilibrium models and Friedmans market selection hypothesis. Finally, we use ex-ante spanned subjective beliefs to study predictions of several reduced-form and structural models and uncover a number of statistically significant relationships in favour of rational expectations.

Central Bank Communication and the Yield Curve

Using the institutional features of ECB monetary policy announcements, we provide direct evidence for the risk premium channel of central bank communication. We show that on days when the ECB announces its monetary policy almost all of the variation of bond yields is driven by communication. Moreover, while the effect of monetary policy is homogeneous across countries before the European debt crisis, we document dramatic differences post crisis and show that communication shocks drive a wedge between peripheral and core yields. We empirically link the periphery-core wedge to break-up and credit risk premia, and study this channel theoretically through the lens of an equilibrium model in which central bank communication reveals information about the state of the economy.