Tuesday, January 11, 2011

Bonds in Constrained Bubble

I characterize a “bubble” as irrational overvaluation based on the belief that potential returns are infinite and pursued by uncharacteristic amounts of money.  Based on this definition, bonds cannot ever be a bubble because potential returns and overvaluation are mathematically constrained by the zero bound of interest rates.  However, after a 30 year run, bonds are a constrained bubble.  I have seen stocks graphed based on long term linear forecasts (most recently and beautifully in Visualizing Economics), but very rarely see a similar chart for bonds, so using the same Shiller dataset, I have plotted bonds with some interesting overlays.


That is a lot of lines, so let’s narrow it down to the experience since 1980 but keeping the long-term framework in mind.


or maybe we can look at bonds one more way in terms of price return on a 5 year rolling basis.  1980-2010 certainly stands out.



2 hours

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