Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates

RePEc Short ID: pca1116
ORCID iD: 0000-0002-7291-590X

Cao, Shuo; Crump, Richard K.; Eusepi, Stefano; Moench, Emanuel

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Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates

Abstract: Using a unique data set of individual professional forecasts, we document disagreement about the future path of monetary policy, particularly at longer horizons. The stark differences in short rate forecasts imply strong disagreement about the risk-return trade-off of longer-term bonds. Longer-horizon short rate disagreement co-moves with term premiums. We estimate an affine term structure model in which investors hold heterogeneous beliefs about the long-run level of rates. Our model fits Treasury yields and the short rate paths predicted by different groups of investors and thus matches the observed differences in expected return profiles. Investors who correctly anticipated the secular decline in rates became increasingly important for the marginal pricing of risk in the Treasury market. Accounting for heterogeneity in investment performance eliminates the downward trend in the term premium.

Keywords: disagreement; heterogeneous beliefs; noisy information; speculations; survey forecasts; yield curves; term premiums;

JEL Classification: D83; D84; E43; G10; G12;