TY - JOUR
AU - Hong,Harrison
AU - Stein,Jeremy C.
TI - A Unified Theory of Underreaction, Momentum Trading and Overreaction in Asset Markets
JF - National Bureau of Economic Research Working Paper Series
VL - No. 6324
PY - 1997
Y2 - December 1997
DO - 10.3386/w6324
UR - http://www.nber.org/papers/w6324
L1 - http://www.nber.org/papers/w6324.pdf
N1 - Author contact info:
Harrison Hong
Department of Economics
Princeton University
26 Prospect Avenue
Princeton, NJ 08540
Tel: 609/258-0259
Fax: 609/258-0771
E-Mail: hh2679@columbia.edu
Jeremy C. Stein
Department of Economics
Harvard University
Littauer 209
Cambridge, MA 02138
Tel: 617/496-6455
E-Mail: jeremy_stein@harvard.edu
AB - We assume that the instantaneous riskless rate reverts towards a central tendency which in turn, is changing stochastically over time. As a result, current short-term rates are not" sufficient to predict future short-term rates movements, as would be the case if the central" tendency was constant. However, since longer-maturity bond prices incorporate information" about the central tendency, longer-maturity bond yields can be used to predict future short-term" rate movements. We develop a two-factor model of the term-structure which implies that a" linear combination of any two rates can be used as a proxy for the central tendency. Based on" this central-tendency proxy, we estimate a model of the one-month rate which performs better" than models which assume the central tendency to be constant.
ER -