Sovereign Bond Return Prediction with Realized Higher Moments

Abstract

This paper analyzes whether realized higher moments are able to predict out-of-sample sovereign bond returns using high-frequency data from the European bond market. We study bond return predictability over tranquil and crisis periods and across core and periphery markets at the index and country level. We provide fresh evidence that realized kurtosis is the dominant predictor of subsequent returns among higher moments and other predictors such as CDS spreads, short-term interest rates and implied stock market volatility. Our findings further underline that sovereign bond return predictability is stronger during crisis periods and more pronounced for bonds of lower credit ratings.

Keywords: Sovereign bond markets, High-frequency data, Realized higher moments, Hyper-skewness, Hyper-kurtosis, Out-of-sample prediction

JEL Classification: C1, G10, G15, G17