Mind the (Convergence) Gap: Bond Predictability Strikes Back!

58 Pages Posted: 17 Mar 2012 Last revised: 28 Sep 2019

See all articles by Andrea Berardi

Andrea Berardi

Ca Foscari University of Venice - Dipartimento di Economia

Michael Markovich

Investment Strategy - Private Banking Wealth Management; Vienna Institute of Finance

Alberto Plazzi

Swiss Finance Institute; Universita' della Svizzera italiana

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Date Written: August 29, 2019

Abstract

We show that the difference between the natural rate of interest and the current level of monetary policy stance, dubbed Convergence Gap (CG), contains information that is valuable for bond predictability. Adding CG in forecasting regressions of bond excess returns significantly raises the R-squared, and restores countercyclical variation in bond risk premia that is otherwise missed by forward rates. The convergence gap also predicts changes in future yields, and consistently plays the role of an unspanned variable within an affine term structure framework. The importance of the gap remains robust out-of-sample, and in countries other than the U.S. Furthermore, its inclusion brings significant economic gains in the context of dynamic conditional asset allocation.

Keywords: Bond Risk Premia, Forward Rates, Monetary Policy, Natural Rate of Interest, Bond Predictability

JEL Classification: E0, E43, G0, G12

Suggested Citation

Berardi, Andrea and Markovich, Michael and Plazzi, Alberto and Tamoni, Andrea, Mind the (Convergence) Gap: Bond Predictability Strikes Back! (August 29, 2019). Swiss Finance Institute Research Paper No. 19-52. Available at SSRN: https://ssrn.com/abstract=2023885 or http://dx.doi.org/10.2139/ssrn.2023885

Andrea Berardi

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy

Michael Markovich

Investment Strategy - Private Banking Wealth Management ( email )

CRTI 4
P.O. Box
Zurich, CH-8070
Switzerland

Vienna Institute of Finance ( email )

Nordbergstrasse 15
Vienna, 1090
Austria

Alberto Plazzi (Contact Author)

Swiss Finance Institute ( email )

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

Universita' della Svizzera italiana ( email )

Via Buffi 13
CH-6900 Lugano
Switzerland

HOME PAGE: http://usi.to/mpy

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

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