Expectation Puzzles, Time-Varying Risk Premia, and Dynamic Models of the Term Structure

30 Pages Posted: 13 Nov 2008

See all articles by Qiang Dai

Qiang Dai

New York University

Kenneth J. Singleton

Stanford University - Graduate School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: September 2000

Abstract

Though linear projections of returns on the slope of the yield curve have contradicted the implications of the traditional "expectations theory," we show that these findings are not puzzling relative to a large class of richer dynamic terms structure models. Specifically, we are able to match all of the key empirical findings reported by Fama and Bliss and Campbell and Shiller, among others, within large subclasses of affine and quadractic-Gaussian term structure models. Key to this matching are parameterizations of the market prices of risk that let us separately "control" the shape of the mean yield curve and the correlation structure of excess returns with the slope of the yield curve. The risk premiums have a simple form consistent with Fama's findings on the predictability of forward rates, and are shown to also be consistent with interest rate, feedback rules used by a monetary authority in setting monetary policy.

Suggested Citation

Dai, Qiang and Singleton, Kenneth J., Expectation Puzzles, Time-Varying Risk Premia, and Dynamic Models of the Term Structure (September 2000). NYU Working Paper No. S-AM-00-01, Available at SSRN: https://ssrn.com/abstract=1300789

Qiang Dai (Contact Author)

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Kenneth J. Singleton

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