Understanding Bond Risk Premia
Northwestern University - Kellogg School of Management
University of Lugano - Institute of Finance
November 15, 2010
We decompose yields into long-horizon expected inflation and maturity-related cycles to study the predictability of bond excess returns. Cycles capture the risk premium and the business cycle variation of short rate expectations. From cycles, we construct a forecasting factor that explains up to above 50% (30%) of in-sample (out-of-sample) variation of annual bond returns. The factor varies at a frequency higher than the business cycle, and predicts real activity at long horizons. It also aggregates information from different macro-finance predictors of bond returns. Our decomposition reveals why bond returns are predictable by a linear combination of forward rates or the term spread.
Number of Pages in PDF File: 62
Keywords: term premia, bond return forecasting factor, macro factors
JEL Classification: E32, E44, G12working papers series
Date posted: November 15, 2010 ; Last revised: December 31, 2011
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo8 in 0.797 seconds