Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity
50 Pages Posted: 15 Mar 2011 Last revised: 27 Sep 2013
Date Written: September 26, 2013
Estimating the liquidity differential between inflation-indexed and nominal bond yields, we separately test for time-varying real rate risk premia, inflation risk premia, and liquidity premia in U.S. and U.K. bond markets. We find strong, model independent evidence that real rate risk premia and inflation risk premia contribute to nominal bond excess return predictability to quantitatively similar degrees. The estimated liquidity premium between U.S. inflation-indexed and nominal yields is systematic, ranges from 30 bps in 2005 to over 150 bps during 2008-2009, and contributes to return predictability in inflation-indexed bonds. We find no evidence that bond supply shocks generate return predictability.
Keywords: Term structure, Real interest rate risk, Inflation risk, Inflation-Indexed Bonds
JEL Classification: G12
Suggested Citation: Suggested Citation