This paper analyzes the term structure of interest rates in an exchange-only Lucas (Econometrica 46:1429–1445, 1978) economy where consumers learn about a stochastic growth rate through observations of the endowment process and an external public signal. We allow for deluded consumers, who exaggerate the degree of covariation between the external public signal and the growth rate. With such consumers, there can be a premium for noisy external public information in long-term bonds and the social value of more precise public information can be negative. Moreover, our model can create excessive yield volatility and deviations from the expectations hypothesis.
Review of Quantitative Finance and Accounting – Springer Journals
Published: May 31, 2012
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