Inflation Bets on the Long Bond. (24th December 2016)

• Record Type: Journal Article
• Authors: Hong, Harrison; Sraer, David; Yu, Jialin
• Is Part Of: Review of financial studies. Volume 30:Number 3(2017:Mar.)
• Page Start: 900
• Page End: 947
• Publication Date: 2016-12-24
• Subjects: G12; Finance -- United States -- Periodicals; Finance -- Periodicals; 332
• DOI: 10.1093/rfs/hhw090
• Languages: English
• ISSNs: 0893-9454

Abstract

Abstract : The liquidity premium theory of interest rates predicts that the Treasury yield curve steepens with inflation uncertainty as investors demand larger risk premiums to hold long-term bonds. By using the dispersion of inflation forecasts to measure this uncertainty, we find the opposite. Since the prices of long-term bonds move more with inflation than short-term ones, investors also disagree and speculate more about long-maturity payoffs with greater uncertainty. Shorting frictions, measured by using Treasury lending fees, then lead long maturities to become overpriced and the yield curve to flatten. We estimate this inflation-betting effect using time variation in inflation disagreement and Treasury supply. Received September 3, 2014; editorial decision August 5, 2016 by Editor Andrew Karolyi