Inflation Bets on the Long Bond

Harrison G. Hong, David Alexandre Sraer, Jialin Yu
2014 Social Science Research Network  
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 longterm 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
more » ... 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. * We thank Andrew Karolyi (Editor) and two anonymous referees for many helpful comments, We also
doi:10.2139/ssrn.2465451 fatcat:33kaycrl2fcbjbg62wj635lzcu