Expected Returns in Treasury Bonds
Northwestern University - Kellogg School of Management
Birkbeck, University of London
January 12, 2015
We study risk premium in US Treasury bonds. We decompose Treasury yields into inflation expectations and maturity-specific interest rate cycles, which we define as variation in yields orthogonal to expected inflation. The short-maturity cycle captures the real short-rate dynamics. Jointly with expected inflation, it comprises the expectations hypothesis (EH) term in the yield curve. Controlling for the EH term, we extract a measure of risk premium variation from yields. The risk premium factor forecasts excess bond returns in and out of sample and subsumes the common bond return predictor obtained as a linear combination of forward rates.
Number of Pages in PDF File: 60
Keywords: term premia, bond return forecasting factor
JEL Classification: E43, G12
Date posted: November 15, 2010 ; Last revised: April 2, 2015
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