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Inflation Bets on the Long Bond

Author

Listed:
  • Harrison Hong
  • David Sraer
  • Jialin Yu

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.

Suggested Citation

  • Harrison Hong & David Sraer & Jialin Yu, 2017. "Inflation Bets on the Long Bond," The Review of Financial Studies, Society for Financial Studies, vol. 30(3), pages 900-947.
    • Handle: RePEc:oup:rfinst:v:30:y:2017:i:3:p:900-947.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhw090
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    Citations

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    Cited by:

    1. Liu, Clark & Wang, Shujing & Wei, K.C. John & Zhong, Ninghua, 2019. "The demand effect of yield-chasing retail investors: Evidence from the Chinese enterprise bond market," Journal of Empirical Finance, Elsevier, vol. 50(C), pages 57-77.
    2. Bekaert, Geert & Engstrom, Eric & Ermolov, Andrey, 2021. "Macro risks and the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 141(2), pages 479-504.
    3. Wang, Hailong & Hu, Duni, 2024. "Heterogeneous beliefs with information processing capacity constraints and asset pricing in a monetary economy," The North American Journal of Economics and Finance, Elsevier, vol. 72(C).

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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