American Economic Review: Insights
ISSN 2640-205X (Print) | ISSN 2640-2068 (Online)
Ambiguity, Nominal Bond Yields, and Real Bond Yields
American Economic Review: Insights
vol. 2,
no. 2, June 2020
(pp. 177–92)
Abstract
This 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.Citation
Zhao, Guihai. 2020. "Ambiguity, Nominal Bond Yields, and Real Bond Yields." American Economic Review: Insights, 2 (2): 177–92. DOI: 10.1257/aeri.20190155Additional Materials
JEL Classification
- D81 Criteria for Decision-Making under Risk and Uncertainty
- D84 Expectations; Speculations
- E23 Macroeconomics: Production
- E31 Price Level; Inflation; Deflation
- E43 Interest Rates: Determination, Term Structure, and Effects
- E44 Financial Markets and the Macroeconomy
- G12 Equities; Fixed Income Securities