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• Article | Journal of Financial Economics | August 2018

  Extrapolation and Bubbles

  Nicholas Barberis, Robin Greenwood, Lawrence Jin and Andrei Shleifer

  We present an extrapolative model of bubbles. In the model, many investors form their demand for a risky asset by weighing two signals: an average of the asset’s past price changes and the asset’s degree of overvaluation. The two signals are in conflict, and investors “waver” over time in the relative weight they put on them. The model predicts that good news about fundamentals can trigger large price bubbles. We analyze the patterns of cash-flow news that generate the largest bubbles, the reasons why bubbles collapse, and the frequency with which they occur. The model also predicts that bubbles will be accompanied by high trading volume and that volume increases with past asset returns. We present empirical evidence that bears on some of the model’s distinctive predictions.

  Keywords: bubble; extrapolation; volume; Price Bubble; Mathematical Methods;

  Citation:

  Barberis, Nicholas, Robin Greenwood, Lawrence Jin, and Andrei Shleifer. "Extrapolation and Bubbles." Journal of Financial Economics 129, no. 2 (August 2018): 203–227.  View Details

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• Working Paper | HBS Working Paper Series | 2018

  The Impact of Pensions and Insurance on Global Yield Curves

  Robin Greenwood and Annette Vissing-Jorgensen

  We document a strong effect of pension and insurance company (P&I) assets on the long end of the yield curve. Using data from 26 countries, the yield spread between 30-year and 10-year government bond yields is negatively related to the ratio of pension assets (in funded and private pension and life insurance arrangements) to GDP, suggesting that preferred-habitat demand by the P&I sector for long-dated assets drives the long end of the yield curve. We draw on changes in regulations in several European countries between 2008 and 2013 to provide well-identified evidence on the effect of the P&I sector on yields and to show that P&I demand is in part driven by hedging linked to the regulatory discount curve. When regulators reduce the dependence of the regulatory discount curve on a particular security, P&I demand for the security falls and its yield increases. We describe settings in which pension discount rules can have a destabilizing impact on bond markets.

  Keywords: pension funds; Investment Funds; Insurance; Assets; Interest Rates; Bonds;

  Citation:

  Greenwood, Robin, and Annette Vissing-Jorgensen. "The Impact of Pensions and Insurance on Global Yield Curves." Harvard Business School Working Paper, No. 18-109, June 2018.  View Details

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• Working Paper | 2018

  Interest Rate Conundrums in the Twenty-First Century

  Samuel G. Hanson, David O. Lucca and Jonathan H. Wright

  A large literature argues that long-term nominal interest rates react far more to high-frequency (daily or monthly) movements in short-term rates than is predicted by the standard expectations hypothesis. We find that, since 2000, this high-frequency sensitivity has grown even stronger in U.S. data. By contrast, the association between low-frequency changes (at 6- or 12-month horizons) in short- and long-term rates, which was equally strong before 2000, has weakened substantially. As a result, "conundrums"---defined as 6- or 12-month periods in which short and long rates move in opposite directions---have become increasingly common. We show that this post-2000 combination of high-frequency "excess sensitivity" and low-frequency "decoupling" of short- and long-term rates arises because increases in short rates temporarily raise the term premium on long-term bonds, leading long rates to temporarily overreact to changes in short rates. This post-2000 phenomenon can be understood using a model in which (i) declines in short rates lead to outward shifts in the demand for long-term bonds--e.g., because some investors "reach for yield"--and (ii) the arbitrage response to these demand shifts is slow. We discuss the implications of our findings for the transmission of monetary policy and the validity of the event-study methodology.

  Keywords: conundrum; monetary policy transmission; Interest Rates;

  Citation:

  Hanson, Samuel G., David O. Lucca, and Jonathan H. Wright. "Interest Rate Conundrums in the Twenty-First Century." Working Paper. (Internet Appendix Here.)  View Details

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