Out-of-sample Predictions of Bond Excess Returns and Forward Rates: An Asset-Allocation Perspective

Abstract

This paper revisits the predictability of bond excess returns by means of long-term forward interest rates. We assess the economic value of out-of-sample forecasting ability of empirical models based on forward rates in a dynamic asset allocation strategy. Our results show that the information content of forward rates does not generate any systematic economic value to investors. The performance of the predictive models against the no-predictability benchmark worsens over time and the few positive performance fees recorded from dynamic portfolio strategies based on forward rates are generally small in size and do not offset realistic transaction costs.

Keywords: bond yields, bond excess returns, predictability

JEL Classification: G0, G1, E0, E4