Predicting Bond Return Predictability

This paper provides empirical evidence on predictable time variations in out-of- sample bond return predictability. Bond return predictability is associated with periods of high (low) economic activity (uncertainty), which implies that violations of the expectations hypothesis are state-dependent and linked to features of the business cycle. These state-dependencies in predictability, established by introducing a new multivariate test for equal conditional predictive ability, can be used in real-time to improve out-of-sample bond risk premia estimates and investors’ economic utility through a novel dynamic forecast combination scheme that uses predicted forecasting performance to identify the best set of methods to include in the combined forecast. Dynamically combined forecasts exhibit strong countercyclical behavior and peak during recessions.

Keywords: bond excess returns, forecasting, state-dependencies, multivariate test, equal conditional predictive ability

JEL Classification: C12, C52, E43, E44, G12

Suggested Citation: Suggested Citation

Borup, Daniel and Eriksen, Jonas Nygaard and Kjær, Mads Markvart and Thyrsgaard, Martin, Predicting Bond Return Predictability (May 6, 2022). Accepted for publication in Management Science , Available at SSRN: https://ssrn.com/abstract=3513340 or http://dx.doi.org/10.2139/ssrn.3513340