Hostname: page-component-586b7cd67f-vdxz6 Total loading time: 0 Render date: 2024-11-22T18:14:40.311Z Has data issue: false hasContentIssue false
  • English
  • Français

Monetary Policy and Bond Prices with Drifting Equilibrium Rates

Published online by Cambridge University Press:  04 January 2023

Carlo A. Favero Open the ORCID record for Carlo A. Favero [Opens in a new window] ,
Alessandro Melone  and
Andrea Tamoni
Carlo A. Favero*
Affiliation:
Bocconi University Department of Finance, Innocenzo Gasparini Institute for Economic Research (IGIER), and Centre for Economic Policy Research (CEPR)
Alessandro Melone
Affiliation:
The Ohio State University Fisher College of Business [email protected]
Andrea Tamoni
Affiliation:
Rutgers Business School [email protected]
*
[email protected] (corresponding author)
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

We study the drift and cyclical components in U.S. Treasury bonds. We find that bond yields are drifting because they reflect the drift in monetary policy rates. Empirically, modeling the monetary policy drift using demographics and productivity trends, plus long-term inflation expectations, leads to cyclical deviations of bond prices from their drift that predict bond returns in- and out-of-sample. These bond cycles can be interpreted as term premia or/and temporary deviations from rational expectations in a behavioral framework. Through the lens of our model, we detect a significant role of the latter in determining the cyclical properties of yields with short maturities.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 59 , Issue 2 , March 2024 , pp. 626 - 651
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (https://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We are grateful to Pierluigi Balduzzi, Hendrik Bessembinder (the editor), John Cochrane, Vito Gala, Kasper Joergensen, Scott Joslin (the referee), Fabio Trojani, Christian Wagner, Josef Zechner, and participants at the LTI/Bank of Italy Workshop 2021, the BFWG Conference 2021 at Queen Mary University of London, the IAAE Annual Conference 2021, the 2021 INQUIRE Residential Seminar, and the 2022 Asset Pricing Workshop for their comments. Alessandro Melone acknowledges the financial support from the Austrian Science Fund (FWF).

References

Ang, A.; Boivin, J.; Dong, S.; and Loo-Kung, R.. “Monetary Policy Shifts and the Term Structure.” Review of Economic Studies, 78 (2011), 429–457.CrossRefGoogle Scholar
Aruoba, S. B., and Schorfheide, F.. “Inflation During and After the Zero Lower Bound.” In 2015 Jackson Hole Symposium Volume, Federal Reserve Bank of Kansas City (2016), 359–436.Google Scholar
Balduzzi, P.; Das, S. R.; and Foresi, S.. “The Central Tendency: A Second Factor in Bond Yields.” Review of Economics and Statistics, 80 (1998), 62–72.CrossRefGoogle Scholar
Bansal, R., and Shaliastovich, I.. “A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets.” Review of Financial Studies, 26 (2013), 1–33.CrossRefGoogle Scholar
Bauer, M. D., and Rudebusch, G. D.. “Interest Rates Under Falling Stars.” American Economic Review, 110 (2020), 1316–1354.CrossRefGoogle Scholar
Bauer, M. D.; Rudebusch, G. D.; and Wu, J. C.. “Term Premia and Inflation Uncertainty: Empirical Evidence from an International Panel Dataset: Comment.” American Economic Review, 104 (2014), 323–337.CrossRefGoogle Scholar
Berardi, A.; Markovich, M.; Plazzi, A.; and Tamoni, A.. “Mind the (Convergence) Gap: Bond Predictability Strikes Back!” Management Science, 67 (2020), 7291–7950.Google Scholar
Bernanke, B. S., and Kuttner, K. N.. “What Explains the Stock Market’s Reaction to Federal Reserve Policy?” Journal of Finance, 60 (2005), 1221–1257.CrossRefGoogle Scholar
Bordalo, P.; Gennaioli, N.; and Shleifer, A.. “Diagnostic Expectations and Credit Cycles.” Journal of Finance, 73 (2018), 199–227.CrossRefGoogle Scholar
Brusa, F.; Savor, P.; and Wilson, M.. “One Central Bank to Rule Them All.” Review of Finance, 24 (2019), 263–304.Google Scholar
Campbell, J. “Long-Term Investing in a Nonstationary World.” NBER Lecture (2019).Google Scholar
Campbell, J. Y., and Shiller, R. J.. “The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors.” Review of Financial Studies, 1 (1988), 195–228.CrossRefGoogle Scholar
Campbell, J. Y., and Shiller, R. J.. “Yield Spreads and Interest Rate Movements: A Bird’s Eye View.” Review of Economic Studies, 58 (1991), 495–514.CrossRefGoogle Scholar
Campbell, J. Y., and Sigalov, R.. “Portfolio Choice with Sustainable Spending: A Model of Reaching for Yield.” NBER Technical Report (2020).CrossRefGoogle Scholar
Campbell, J. Y., and Thompson, S. B.. “Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?” Review of Financial Studies, 21 (2008), 1509–1531.CrossRefGoogle Scholar
Chava, S., and Hsu, A.. “Financial Constraints, Monetary Policy Shocks, and the Cross-Section of Equity Returns.” Review of Financial Studies, 33 (2020), 4367–4402.CrossRefGoogle Scholar
Cieslak, A. “Short-Rate Expectations and Unexpected Returns in Treasury Bonds.” Review of Financial Studies, 31 (2018), 3265–3306.CrossRefGoogle Scholar
Cieslak, A., and Povala, P.. “Expected Returns in Treasury Bonds.” Review of Financial Studies, 28 (2015), 2859–2901.CrossRefGoogle Scholar
Clarida, R.; Gali, J.; and Gertler, M.. “Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory.” Quarterly Journal of Economics, 115 (2000), 147–180.CrossRefGoogle Scholar
Clark, T., and West, K.. “Approximately Normal Tests for Equal Predictive Accuracy in Nested Models.” Journal of Econometrics, 138 (2007), 291–311.CrossRefGoogle Scholar
Cochrane, J. H. “Comments on ‘Macroeconomic Implications of Changes in the Term Premium’.” Federal Reserve Bank of St. Louis Review, 89 (2007), 271–282.Google Scholar
Cochrane, J. H., and Piazzesi, M.. “Bond Risk Premia.” American Economic Review, 95 (2005), 138–160.CrossRefGoogle Scholar
Cogley, T.; Primiceri, G. E.; and Sargent, T. J.. “Inflation-Gap Persistence in the US.” American Economic Journal: Macroeconomics, 2 (2010), 43–69.Google Scholar
Coibion, O., and Gorodnichenko, Y.. “Monetary Policy, Trend Inflation, and the Great Moderation: An Alternative Interpretation.” American Economic Review, 101 (2011), 341–370.CrossRefGoogle Scholar
Coibion, O., and Gorodnichenko, Y.. “Why Are Target Interest Rate Changes So Persistent?” American Economic Journal: Macroeconomics, 4 (2012), 126–162.Google Scholar
Cooper, I., and Priestley, R.. “Time-Varying Risk Premiums and the Output Gap.” Review of Financial Studies, 22 (2008), 2801–2833.CrossRefGoogle Scholar
d’Arienzo, D. “Increasing Overreaction and Excess Volatility of Long Rates.” Working Paper, Bocconi University (2020).Google Scholar
Dahlquist, M., and Hasseltoft, H.. “International Bond Risk Premia.” Journal of International Economics, 90 (2013), 17–32.CrossRefGoogle Scholar
Duffee, G. R. “Term Premia and Interest Rate Forecasts in Affine Models.” Journal of Finance, 57 (2002), 405–443.CrossRefGoogle Scholar
Duffee, G. R. “Forecasting Interest Rates.” In Handbook of Economic Forecasting, Vol. 2 of Handbook of Economic Forecasting, Elliott, G., Granger, C., and Timmermann, A., eds. Amsterdam, Netherlands: Elsevier (2013), 385–426.Google Scholar
Engle, R. F., and Granger, C. W.. “Co-Integration and Error Correction: Representation, Estimation, and Testing.” Econometrica, 55 (1987), 251–276.CrossRefGoogle Scholar
Fama, E. F. “The Behavior of Interest Rates.” Review of Financial Studies, 19 (2006), 359–379.CrossRefGoogle Scholar
Fama, E. F., and Bliss, R. R.. “The Information in Long-Maturity Forward Rates.” American Economic Review, 77 (1987), 680–692.Google Scholar
Farhi, E., and Gourio, F.. “Accounting for Macro-Finance Trends: Market Power, Intangibles, and Risk Premia.” NBER Technical Report (2018).Google Scholar
Feunou, B., and Fontaine, J.-S.. “Secular Economic Changes and Bond Yields.” Review of Economics and Statistics, forthcoming, https://doi.org/10.1162/rest_a_01034 (2023).CrossRefGoogle Scholar
Geanakoplos, J.; Magill, M.; and Quinzii, M.. “Demography and the Long-Run Predictability of the Stock Market.” Brookings Papers on Economic Activity, 2004 (2002), 241–325.CrossRefGoogle Scholar
Gennaioli, N., and Shleifer, A.. A Crisis of Beliefs: Investor Psychology and Financial Fragility. Princeton, NJ: Princeton University Press (2018).Google Scholar
Gertler, M.; Gali, J.; and Clarida, R.. “The Science of Monetary Policy: A New Keynesian Perspective.” Journal of Economic Literature, 37 (1999), 1661–1707.Google Scholar
Giammarioli, N., and Valla, N.. “The Natural Real Interest Rate and Monetary Policy: A Review.” Journal of Policy Modeling, 26 (2004), 641–660.CrossRefGoogle Scholar
Giannone, D.; Lenza, M.; and Primiceri, G. E.. “Priors for the Long Run.” Journal of the American Statistical Association, 114 (2019), 565–580.CrossRefGoogle Scholar
Golinski, A., and Zaffaroni, P.. “Long Memory Affine Term Structure Models.” Journal of Econometrics, 191 (2016), 33–56.CrossRefGoogle Scholar
Gürkaynak, R. S.; Sack, B.; and Wright, J. H.. “The US Treasury Yield Curve: 1961 to the Present.” Journal of Monetary Economics, 54 (2007), 2291–2304.CrossRefGoogle Scholar
Hall, A. D.; Anderson, H. M.; and Granger, C. W. J.. “A Cointegration Analysis of Treasury Bill Yields.” Review of Economics and Statistics, 74 (1992), 116–126.CrossRefGoogle Scholar
Hodrick, R. J. “Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement.” Review of Financial Studies, 5 (1992), 357–386.CrossRefGoogle Scholar
Jardet, C.; Monfort, A.; and Pegoraro, F.. “No-Arbitrage Near-Cointegrated VAR(p) Term Structure Models, Term Premia and GDP Growth.” Journal of Banking & Finance, 37 (2013), 389–402.CrossRefGoogle Scholar
Jordà, Ò., and Taylor, A. M.. “Riders on the Storm.” NBER Technical Report (2019).CrossRefGoogle Scholar
Jørgensen, K. “How Learning from Macroeconomic Experiences Shapes the Yield Curve.” Finance and Economics Discussion Series 2018, Board of Governors of the Federal Reserve System (2018).CrossRefGoogle Scholar
Joslin, S.; Le, A.; and Singleton, K. J.. “Why Gaussian Macro-Finance Term Structure Models are (nearly) Unconstrained Factor-VARs.” Journal of Financial Economics, 109 (2013), 604–622.CrossRefGoogle Scholar
Kiley, M. T. “What Can the Data Tell Us About the Equilibrium Real Interest Rate?” Finance and Economics Discussion Series 2015-77, Board of Governors of the U. S. Federal Reserve System (2015).CrossRefGoogle Scholar
Koijen, R. S.; Lustig, H.; and Van Nieuwerburgh, S.. “The Cross-Section and Time Series of Stock and Bond Returns.” Journal of Monetary Economics, 88 (2017), 50–69.CrossRefGoogle Scholar
Kozicki, S., and Tinsley, P. A.. “Shifting Endpoints in the Term Structure of Interest Rates.” Journal of Monetary Economics, 47 (2001), 613–652.CrossRefGoogle Scholar
Laubach, T., and Williams, J. C.. “Measuring the Natural Rate of Interest.” Review of Economics and Statistics, 85 (2003), 1063–1070.CrossRefGoogle Scholar
Lettau, M., and Ludvigson, S.. “Consumption, Aggregate Wealth, and Expected Stock Returns.” Journal of Finance, 56 (2001), 815–849.CrossRefGoogle Scholar
Ludvigson, S. C., and Ng, S.. “Macro Factors in Bond Risk Premia.” Review of Financial Studies, 22 (2009), 5027–5067.CrossRefGoogle Scholar
Lunsford, K. G., and West, K. D.. “Some Evidence on Secular Drivers of US Safe Real Rates.” American Economic Journal: Macroeconomics, 11 (2019), 113–139.Google Scholar
MacKinnon, J. G. “Critical Values for Cointegration Tests.” Technical Report, Queen’s Economics Department (2010).Google Scholar
Maxted, P. “A Macro-Finance Model with Sentiment.” Working Paper, Harvard University (2019).Google Scholar
Miranda-Agrippino, S., and Rey, H.. “U.S. Monetary Policy and the Global Financial Cycle.” Review of Economic Studies, 87 (2020), 2754–2776.CrossRefGoogle Scholar
Negro, M. D.; Giannone, D.; Giannoni, M. P.; and Tambalotti, A.. “Safety, Liquidity, and the Natural Rate of Interest.” Brookings Papers on Economic Activity, 48 (2017), 235–316.CrossRefGoogle Scholar
Orphanides, A. “Historical Monetary Policy Analysis and the Taylor Rule.” Journal of Monetary Economics, 50 (2003), 983–1022.CrossRefGoogle Scholar
Ortu, F.; Severino, F.; Tamoni, A.; and Tebaldi, C.. “A Persistence-Based Wold-Type Decomposition for Stationary Time Series.” Quantitative Economics, 11 (2020), 203–230.CrossRefGoogle Scholar
Ozdagli, A. K. “Financial Frictions and the Stock Price Reaction to Monetary Policy.” Review of Financial Studies, 31 (2018), 3895–3936.Google Scholar
Pasten, E.; Schoenle, R.; and Weber, M.. “The Propagation of Monetary Policy Shocks in a Heterogeneous Production Economy.” Journal of Monetary Economics, 116 (2020), 1–22.CrossRefGoogle Scholar
Phillips, P. C., and Perron, P.. “Testing for a Unit Root in Time Series Regression.” Biometrika, 75 (1988), 335–346.CrossRefGoogle Scholar
Piazzesi, M., and Cochrane, J.. “Decomposing the Yield Curve.” Technical Report, University of Chicago (2008).Google Scholar
Piazzesi, M.; Salomao, J.; and Schneider, M.. “Trend and Cycle in Bond Premia.” Working Paper, Stanford University (2015).Google Scholar
Rudebusch, G. D. “Term Structure Evidence on Interest Rate Smoothing and Monetary Policy Inertia.” Journal of Monetary Economics, 49 (2002), 1161–1187.CrossRefGoogle Scholar
Rudebusch, G. D. “Monetary Policy Inertia: Fact or Fiction?” Technical Report 4, Federal Reserve Bank of San Francisco (2006).CrossRefGoogle Scholar
Sarno, L.; Schneider, P.; and Wagner, C.. “The Economic Value of Predicting Bond Risk Premia.” Journal of Empirical Finance, 37 (2016), 247–267.CrossRefGoogle Scholar
Swanson, E. T., and Williams, J. C.. “Measuring the Effect of the Zero Lower Bound on Medium-and Longer-Term Interest Rates.” American Economic Review, 104 (2014), 3154–85.CrossRefGoogle Scholar
Taylor, J. B., “Discretion Versus Policy Rules in Practice.” Carnegie-Rochester Conference Series on Public Policy, 39 (1993), 195–214.CrossRefGoogle Scholar
van Binsbergen, J. H. “Duration-Based Stock Valuation.” NBER Working Paper No. 27367 (2020).CrossRefGoogle Scholar
Woodford, M. “The Taylor Rule and Optimal Monetary Policy.” American Economic Review, 91 (2001), 232–237.CrossRefGoogle Scholar
Woodford, M. “Optimal Interest-Rate Smoothing.” Review of Economic Studies, 70 (2003), 861–886.CrossRefGoogle Scholar
Wright, J. H. “Term Premia and Inflation Uncertainty: Empirical Evidence from an International Panel Dataset.” American Economic Review, 101 (2011), 1514–1534.CrossRefGoogle Scholar
Wright, J. H. “Term Premia and Inflation Uncertainty: Empirical Evidence from an International Panel Dataset: Reply.” American Economic Review, 104 (2014), 338–341.CrossRefGoogle Scholar
Supplementary material: PDF

Favero et al. supplementary material

Online Appendix

Download Favero et al. supplementary material(PDF)
PDF 272.9 KB