TY  - JOUR
AU  - Xiong,Wei
AU  - Yan,Hongjun
TI  - Heterogeneous Expectations and Bond Markets
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12781
PY  - 2006
Y2  - December 2006
UR  - http://www.nber.org/papers/w12781
L1  - http://www.nber.org/papers/w12781.pdf
N1  - Author contact info:
Wei Xiong
Princeton University
Department of Economics
Bendheim Center for Finance
Princeton, NJ  08450
Tel: 609/258-0282
Fax: 609/258-0771
E-Mail: wxiong@princeton.edu

Hongjun Yan
Yale School of Management
135 Prospect Street
Box  208200
New Haven, CT 06520-8200
Tel: (203) 432-6277
E-Mail: hongjun.yan@yale.edu
AB  - This paper presents a dynamic equilibrium model of bond markets, in which two groups of agents hold heterogeneous expectations about future economic conditions. Our model  shows that heterogeneous expectations can not only lead to speculative trading, but can also help resolve several challenges to standard representative-agent models of the yield curve. First, the relative wealth fluctuation between the two groups of agents caused by their speculative positions amplifies bond yield volatility, thus providing an explanation for the "excessive volatility puzzle" of bond yields. In addition, the fluctuation in the two groups' expectations and relative wealth also generates time-varying risk premia, which in turn can help explain the failure of the expectation hypothesis. These implications, essentially induced by trading between agents, highlight the importance of incorporating heterogeneous expectations into economic analysis of bond markets.
ER  -