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Ambiguity, Nominal Bond Yields and Real Bond Yields

Author

Listed:
  • Guihai Zhao
Abstract
Equilibrium bond-pricing models rely on inflation being bad news for future growth to generate upward-sloping nominal yield curves. We develop a model that can generate upward-sloping nominal and real yield curves by instead using ambiguity about inflation and growth. Ambiguity can help resolve the puzzling fact that upward-sloping yield curves have persisted despite positive inflation shocks changing from negative to positive news about growth in the last twenty years. Investors make decisions using worst-case beliefs, under which the expectations hypothesis roughly holds. However, inflation and growth evolve over time under the true distribution, and this difference makes excess returns on long-term bonds predictable. The model is also consistent with the recent empirical findings on the term structure of equity returns.

Suggested Citation

  • Guihai Zhao, 2018. "Ambiguity, Nominal Bond Yields and Real Bond Yields," Staff Working Papers 18-24, Bank of Canada.
    • Handle: RePEc:bca:bocawp:18-24
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    References listed on IDEAS

    as
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    Cited by:

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    2. Thomas J. Sargent & John Stachurski, 2024. "Dynamic Programming: Finite States," Papers 2401.10473, arXiv.org.
    3. Guihai Zhao, 2020. "Learning, Equilibrium Trend, Cycle, and Spread in Bond Yields," Staff Working Papers 20-14, Bank of Canada.
    4. Ming Zeng & Guihai Zhao, 2022. "Expectation-Driven Term Structure of Equity and Bond Yields," Staff Working Papers 22-21, Bank of Canada.
    5. Joseph G. Haubrich, 2021. "Does the Yield Curve Predict Output?," Annual Review of Financial Economics, Annual Reviews, vol. 13(1), pages 341-362, November.
    6. Danilo Cascaldi-Garcia & Cisil Sarisoy & Juan M. Londono & Bo Sun & Deepa D. Datta & Thiago Ferreira & Olesya Grishchenko & Mohammad R. Jahan-Parvar & Francesca Loria & Sai Ma & Marius Rodriguez & Ilk, 2023. "What Is Certain about Uncertainty?," Journal of Economic Literature, American Economic Association, vol. 61(2), pages 624-654, June.
    7. Karahan, Cenk C. & Soykök, Emre, 2022. "Term premium dynamics in an emerging market: Risk, liquidity, and behavioral factors," International Review of Financial Analysis, Elsevier, vol. 84(C).
    8. Qiang Chen & Yu Han & Ying Huang, 2024. "Market‐wide overconfidence and stock returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(1), pages 3-26, January.

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    More about this item

    Keywords

    Asset Pricing; Financial markets; Interest rates;
    All these keywords.

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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