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Expectation Formation in the Treasury Bond Market

I document that subjective bond risk premia implied by survey forecasts of future Treasury yields are acyclical at the one-year horizon. This is in stark contrast to large countercyclical variation in objective risk premia fitted from in-sample predictive regressions of future bond excess returns. This difference in risk premia implies a wedge between subjective and objective expectations of future short rates, which I show is predictable by trend and cycle components of macroeconomic forecasts. I show that these empirical findings can be explained with a learning model in which the agent filters latent trend and cycle components of fundamentals in real time, while an econometrician analyzing the data ex-post has full knowledge of the data-generating processes. The model also yields predictions, consistent with the data, on the joint behavior of the unconditional yield curve slope, the cyclicality of short-rate and macroeconomic expectation wedges, and the cyclicality of objective risk premia. My results suggest that equilibrium models of bond risk premia should target acyclical subjective risk premia and expectation formation, rather than ex-post in-sample fitted risk premia from predictive regressions.