A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets

44 Pages Posted: 8 Sep 2012

See all articles by Ravi Bansal

Ravi Bansal

Duke University and NBER

Ivan Shaliastovich

University of Wisconsin - Madison

Date Written: September 2012

Abstract

We show that bond risk-premia rise with uncertainty about expected inflation and fall with uncertainty about expected growth; the magnitude of return predictability using these two uncertainty measures is similar to that by multiple yields. Motivated by this evidence, we develop and estimate a long-run risks model with time-varying volatilities of expected growth and inflation. The model simultaneously accounts for bond return predictability and violations of uncovered interest parity in currency markets. We find that preference for early resolution of uncertainty, time-varying volatilities, and non-neutral effects of inflation on growth are important to account for these aspects of asset markets.

Suggested Citation

Bansal, Ravi and Shaliastovich, Ivan, A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets (September 2012). NBER Working Paper No. w18357, Available at SSRN: https://ssrn.com/abstract=2143544

Ravi Bansal (Contact Author)

Duke University and NBER ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7758 (Phone)
919-660-8038 (Fax)

Ivan Shaliastovich

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

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