Ambiguous Information about Interest Rates and Bond Uncertainty Premiums

Abstract

This paper studies the impact of ambiguous information regarding future interest rates on bond prices. A simple bond-pricing model with ambiguity aversion shows that positive bond uncertainty premiums exist, and the interest rate ambiguity affects the term structure of interest rates and yield volatilities. Consistent with the theory, empirical measures of interest rate ambiguity based on the Survey of Professional Forecasters data significantly predict U.S. Treasury bond returns, explain variation in term spreads and yield volatility, and bond yields asymmetrically respond to good and bad news from the Federal Reserve. Results are robust to alternative empirical specifications and out-of-sample forecasts.