Behavioral biases, information frictions and interest rate expectations

George Bulkley, Richard D.F. Harris and Vivekanand Nawosah

Journal of Empirical Finance, 2025, vol. 83, issue C

Abstract: We use expectations of the short rate inferred from the term structure of interest rates to test several well-known models of behavioral biases and information frictions. We classify signals about future short rates by their cost of acquisition and find evidence of overreaction to high-cost signals and underreaction to low-cost signals, providing support for the overconfidence bias. We show that our results are unlikely to be driven by time-varying risk premia. The biases are so large that the market’s forecast errors are larger at all horizons than for forecasts obtained by assuming that the short rate follows a random walk.

Keywords: Behavioral bias; Information frictions; Expectations hypothesis of the term structure of interest rates; Underreaction; Overreaction (search for similar items in EconPapers)
JEL-codes: G02 G12 G14 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:83:y:2025:i:c:s0927539825000593

DOI: 10.1016/j.jempfin.2025.101637

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