TRADING CASE GC1
News, expectations, and bond prices
LEARNING OBJECTIVE
Use discounting and evolving news to connect interest-rate expectations with bond prices.
KEY CONCEPTS
Time value of money | Discounting | Bond prices and interest rates | News and rate expectations

FIVE-PERIOD MARKET

Each trial has five periods. Periods 1-4 last 300 seconds and permit trading. Period 5 opens briefly only for final settlement. Round 1 contains three independent trials.

RATES AND DEPENDENCE

Year 1 is 2%. Years 2-5 can be 1%-5%; without news each outcome is equally likely and the expected rate is 3%. Adjacent years have about 0.4 correlation.

POSITIONS AND TRADING

Traders start with different long/short portfolios having the same pre-news present value. Limit and market orders are allowed, along with borrowing and short sales.

BOND CASH FLOWS

SecurityYear 1Year 2Year 3Year 4Year 5
Cp Bond5555105
Zero C20100000
Zero C30010000
Zero C40001000
Zero C50000100

HOW NEWS CHANGES PRICE DISCOVERY

Period 1 headlines forecast Year 2, Period 2 forecasts Year 3, and so on. Headlines equal the true next-year rate plus independent, unbiased noise. Later reports are more precise, and several reports are more informative than one.

Click a security name to view headlines. The newest appears at the top. Compare news with bids, asks, and trades to judge how quickly expectations enter prices.

TRADING CASE GC1 - NEWS APPENDIX

Actual headlines by the rate interval they signal
The 1%-5% range is divided into ten 0.4-point intervals. Headlines are independent, unbiased but noisy forecasts of the next year's true rate. Errors become smaller during the trading period; by the fifth headline the signal is within approximately one interval of the true case.
CASE 1(1.0%-1.4%]
  • Economic forecasts call for decline in GDP
  • Recession more likely say economists
  • No breakthrough at the UN; crisis continues
  • Consumer confidence is widely tipped at lowest level for over a decade
CASE 2(1.4%-1.8%]
  • Consumer confidence falls, signaling decline in spending
  • Inventory buildup points to signs of recession
CASE 3(1.8%-2.2%]
  • Early trend in recession, forward indicators raise new questions about the economy
  • Consumer spending suggests that a declining trend has started.
CASE 4(2.2%-2.6%]
  • Some major corporations have started to trim work force
  • Geopolitical concerns starting to worry investors
CASE 5(2.6%-3.0%]
  • Leading economic indicators match expectations
  • Stock funds experiencing mild selling
CASE 6(3.0%-3.4%]
  • Leading indicators suggest positive economic outlook
  • Fed chairman congressional testimony provides optimism
CASE 7(3.4%-3.8%]
  • Indicators are reinforcing a positive economic outlook
  • Geopolitical investment concerns are rapidly fading
CASE 8(3.8%-4.2%]
  • Analyst forecast increased earnings for most industries in the economy
  • Factory orders expected to increase sharply
CASE 9(4.2%-4.6%]
  • Much stronger economic growth is currently being forecast
  • Sharp jump in strong GDP forecasts
CASE 10(4.6%-5.0%]
  • Inflationary expectations increased sharply
  • Very strong and unexpected surge in the producer price index
  • Large jump in both imports and exports plus trade deficit sharply wider
  • Consumer price index expected to surge