This paper presents a dynamic equilibrium model of bond markets in which two groups of agents hold heterogeneous expectations about future economic conditions. The heterogeneous expectations cause agents to take speculative positions against each other and therefore generate endogenous relative wealth fluctuation. The relative wealth fluctuation amplifies asset price volatility and contributes to the time variation in bond premia. Our model shows that a modest amount of heterogeneous expectation can help explain several puzzling phenomena, including the quot;excessive volatilityquot; of bond yields, the failure of the expectations hypothesis, and the ability of a tent-shaped linear combination of forward rates to predict bond returns.

Real world investors differ in their tastes and attitudes and they do not have, in general, perfect information about the future prospects of the economy. Most theoretical models, however, assume to the contrary that investors are homogeneous and perfectly informed about the market. In this book, an attempt is made to overcome these shortcomings. In three different case studies, the effect of heterogeneous time preferences, heterogeneous beliefs and imperfect information about the economy's growth on the term structure of interest rates are studied. The initial chapter gives an introduction to the theory of financial markets in continuous time under imperfect information and establishes the existence of an equilibrium with complete markets.

An affine no-arbitrage asset pricing framework is developed that allows for agents to have rational but heterogeneous expectations. The framework can match both bond yields and the observed dispersion of yield expectations in survey data. heterogeneous information introduces a speculative component in bond prices that (i) is statistically distinct from classical components such as risk-premia and expectations about future short rates and (ii) quantitatively important, at times accounting for up to 125 basis points of US yields. Allowing for heterogeneous expectations also changes the estimated relative importance of risk-premia and expectations about future short rates in historical bond yields compared to a standard affine model. The framework imposes weaker restrictions than existing heterogeneous information asset pricing models and is thus well-suited to empirically quantify the importance of relaxing the common information assumption.

This paper develops a dynamic programming model of the optimal refunding strategy and the corresponding value of a callable bond. The model differs from previous work on this subject primarily in that it explicitly admits the possibility of differences between the issuer's expectations of future interest rates and an investor's corresponding expectations. This generalization facilitates the application of the model to determine what a specific bond (issued, for example, by a particular corporation) is worth to any given investor. Additional analytical features of the model, which differ from corresponding aspects of some previous models, include the use of a stochastic discounting rate and the use of continuous distributions to characterize the relevant interest rate expectations. For the bond issuer, his own expectations (together with the bond's coupon and call features) suffice to indicate the critical refunding yield as well as the expected value of the bond in each time period until the bond matures. For an investor, however, the analytical solution of the model and the illustrative numerical examples presented in the paper show that the issuer's expectations and the investor's own both matter if the two differ.

The Handbook on Systemic Risk, written by experts in the field, provides researchers with an introduction to the multifaceted aspects of systemic risks facing the global financial markets. The Handbook explores the multidisciplinary approaches to analyzing this risk, the data requirements for further research, and the recommendations being made to avert financial crisis. The Handbook is designed to encourage new researchers to investigate a topic with immense societal implications as well as to provide, for those already actively involved within their own academic discipline, an introduction to the research being undertaken in other disciplines. Each chapter in the Handbook will provide researchers with a superior introduction to the field and with references to more advanced research articles. It is the hope of the editors that this Handbook will stimulate greater interdisciplinary academic research on the critically important topic of systemic risk in the global financial markets.