Expected Returns in Treasury Bonds
Northwestern University - Kellogg School of Management
Birkbeck, University of London
January 12, 2015
We study time-varying expected returns in Treasury bonds. We decompose Treasury yields into inflation expectations and maturity-specific cycles, which we define as the component in yields orthogonal to expected inflation. The short-maturity cycle captures the dynamics in the real short rate at the business cycle frequency. Jointly with expected inflation it comprises the expectations hypothesis (EH) term in the yield curve. Controlling for the EH term allows us to extract a measure of risk premium variation from yields. The risk premium factor varies at a frequency higher than the business cycle and forecasts excess bond returns in and out of sample. It also subsumes the commonly used return predictor obtained as a linear combination of forward rates.
Number of Pages in PDF File: 54
Keywords: term premia, bond return forecasting factor
JEL Classification: E32, E44, G12working papers series
Date posted: November 15, 2010 ; Last revised: January 12, 2015
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