e.g., expected future business conditions demographics (lifecycle theory of saving) business cycles, changes in risk & liquidity - post-2009 did low long-term yields reflect pessimism about economic recovery? e.g. Paul Krugman - Late-2016 to early 2017: do rising long-term yields reflect optimism about future growth? (b) Expected Inflation: - determines the difference between the real and nominal yield. - works through the Fisher effect. - often discussed as if it is a key determinant of future yields. - Expectations theory suggests that the observed term structure can be used to identify current lender expectations (yields). e.g. R1 > R2 implies that E11 > R1 : (one-year are expected to rise) i.e., the term structure can be used as a way of forecasting future rates. - Sometimes these are used to estimate expected inflation - assumes that expected real yield is constant. Liquidity Preference, Risk and Term Structure: an Extension of Expectations Theory - Long and short-term bonds are not perfect substitutes. - Liquidity preference assumes there may be preference for short-term assets. - Longer term bonds may be regarded as riskier. Why? - More exposed to inflation risk (greater uncertainty regarding future
e.g., expected future business conditions demographics (lifecycle theory of saving) business cycles, changes in risk & liquidity - post-2009 did low long-term yields reflect pessimism about economic recovery? e.g. Paul Krugman - Late-2016 to early 2017: do rising long-term yields reflect optimism about future growth? (b) Expected Inflation: - determines the difference between the real and nominal yield. - works through the Fisher effect. - often discussed as if it is a key determinant of future yields. - Expectations theory suggests that the observed term structure can be used to identify current lender expectations (yields). e.g. R1 > R2 implies that E11 > R1 : (one-year are expected to rise) i.e., the term structure can be used as a way of forecasting future rates. - Sometimes these are used to estimate expected inflation - assumes that expected real yield is constant. Liquidity Preference, Risk and Term Structure: an Extension of Expectations Theory - Long and short-term bonds are not perfect substitutes. - Liquidity preference assumes there may be preference for short-term assets. - Longer term bonds may be regarded as riskier. Why? - More exposed to inflation risk (greater uncertainty regarding future
money_fall17g.docx