Authors: Shuo Cao, Richard K. Crump, Stefano Eusepi, and Emanuel Moench
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Staff Reports
Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates
Number 934
July 2020 Revised August 2021
July 2020 Revised August 2021
JEL classification: D83, D84, E43, G10, G12
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.
AUTHOR DISCLOSURE STATEMENT(S)
Shuo Cao
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates,” joint with Richard Crump, Stefano Eusepi, and Emanuel Moench.
Richard K. Crump
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates,” joint with Shuo Cao, Stefano Eusepi, and Emanuel Moench. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Stefano Eusepi
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates,” joint with Shuo Cao, Richard Crump, and Emanuel Moench.
Emanuel Moench
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates,” joint with Shuo Cao, Richard Crump, and Stefano Eusepi.
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates,” joint with Richard Crump, Stefano Eusepi, and Emanuel Moench.
Richard K. Crump
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates,” joint with Shuo Cao, Stefano Eusepi, and Emanuel Moench. Prior to circulation, this paper was reviewed in accordance with the Federal Reserve Bank of New York review policy, available at https://www.newyorkfed.org/research/staff_reports/index.html.
Stefano Eusepi
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates,” joint with Shuo Cao, Richard Crump, and Emanuel Moench.
Emanuel Moench
I declare that I have no relevant or material financial interests that relate to the research described in my paper entitled “Fundamental Disagreement about Monetary Policy and the Term Structure of Interest Rates,” joint with Shuo Cao, Richard Crump, and Stefano Eusepi.
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