We study the link between investment boom and bust cycles and returns on capital in the dry bulk shipping industry. We show that high current ship earnings are associated with high used ship prices and heightened industry investment in new ships, but forecast low future returns. We propose and estimate a behavioral model of industry cycles that can account for the evidence. In our model, firms overextrapolate exogenous demand shocks and partially neglect the endogenous investment response of their competitors. As a result, firms overpay for ships and overinvest in booms and are disappointed by the subsequent low returns. Formal estimation of the model suggests that modest expectational errors can result in dramatic excess volatility in prices and investment.

We develop a model in which specialized bond investors must absorb shocks to the supply and demand for long-term bonds in two currencies. Since long-term bonds and foreign exchange are both exposed to unexpected movements in short-term interest rates, a shift in the supply of long-term bonds in one currency influences the foreign exchange rate between the two currencies, as well as bond term premia in both currencies. Our model matches several important empirical patterns, including the comovement between exchange rates and term premia, and the finding that central banks’ quantitative easing policies affect exchange rates. An extension of our model links spot exchange rates to the persistent deviations from covered interest rate parity that have emerged since 2008.

Long-term nominal interest rates are surprisingly sensitive to high-frequency (daily or monthly) movements in short-term rates. Since 2000, this high-frequency sensitivity has grown even stronger in U.S. data. By contrast, the association between low-frequency changes (at 6- or 12-month horizons) in long- and short-term rates, which was also strong before 2000, has weakened substantially. This puzzling post-2000 pattern arises because increases in short rates temporarily raise the term premium component of long-term yields, leading long rates to temporarily overreact to changes in short rates. The frequency-dependent excess sensitivity of long-term rates that we observe in recent years is best understood using a model in which (i) declines in short rates trigger “rate-amplifying” shifts in investor demand for long-term bonds, and (ii) the arbitrage response to these demand shifts is both limited and slow. We study, theoretically and empirically, how such rate-amplifying demand can be traced to mortgage-refinancing activity, investors who extrapolate recent changes in short rates, and investors who “reach for yield” when short rates fall. We discuss the implications of our findings for the validity of event study methodologies and the transmission of monetary policy.