Abstract: The liquidity premium theory of interest rates predicts that the Treasury yield curve steepens with inflation uncertainty as investors demand larger risk premia to hold long-term bonds. 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 using Treasury lending fees, then lead long maturities to become over-priced and the yield curve to flatten. We estimate this inflation-betting effect using time variation in inflation disagreement and Treasury supply.
Publication Year: 2014
Publication Date: 2014-01-01
Language: en
Type: article
Indexed In: ['crossref']
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Cited By Count: 4
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