Speculative dynamics in the term structure of interest rates

When long maturity bonds are traded frequently and rational traders have non-nested information sets, speculative behavior arises. Using a term structure model displaying such speculative behavior, this paper demonstrates that (i) dispersion of expectations about future short rates is sufficient for individual traders to systematically predict excess returns and (ii) the new term structure dynamics driven by speculative trade is orthogonal to public information in real time, but (iii) can nevertheless be quantified using only publicly available yield data. Speculative dynamics are found to be quantitatively important, potentially accounting for a substantial fraction of the variation of US bond yields.