Inflation Bets on the Long Bond

Harrison Hong, David Sraer and Jialin Yu

The Review of Financial Studies, 2017, vol. 30, issue 3, 900-947

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.

JEL-codes: G12 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (3)

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