The Economic Value of Predicting Bond Risk Premia

77 Pages Posted: 15 Feb 2012 Last revised: 27 Apr 2016

See all articles by Lucio Sarno

Lucio Sarno

City University London - Sir John Cass Business School; Centre for Economic Policy Research (CEPR)

Paul Schneider

University of Lugano - Institute of Finance; Swiss Finance Institute

Christian Wagner

WU Vienna University of Economics and Business; Vienna Graduate School of Finance (VGSF)

Date Written: February 10, 2016

Abstract

This paper studies whether the evident statistical predictability of bond risk premia translates into economic gains for investors. We propose a novel estimation strategy for ane term structure models that jointly fits yields and bond excess returns, thereby capturing predictive information otherwise hidden to standard es- timations. The model predicts excess returns with high regressions R^2s and high forecast accuracy but cannot outperform the expectations hypothesis out-of-sample in terms of economic value, showing a general contrast between statistical and economic metrics of forecast evaluation. More specifically, the model mostly gener- ates positive (negative) economic value during times of high (low) macroeconomic uncertainty. Overall, the expectation hypothesis remains a useful benchmark for investment decisions in bond markets, especially in low uncertainty states.

Keywords: term structure of interest rates, expectations hypothesis, affine models, risk premia, statistical predictability, economic value

JEL Classification: E43, G12

Suggested Citation

Sarno, Lucio and Schneider, Paul Georg and Wagner, Christian, The Economic Value of Predicting Bond Risk Premia (February 10, 2016). Available at SSRN: https://ssrn.com/abstract=2005178 or http://dx.doi.org/10.2139/ssrn.2005178

Lucio Sarno (Contact Author)

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Paul Georg Schneider

University of Lugano - Institute of Finance ( email )

Via Buffi 13
CH-6900 Lugano
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Christian Wagner

WU Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

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