Download this Paper Open PDF in Browser

Bond Risk Premia and Gaussian Term Structure Models

Forthcoming, Management Science

63 Pages Posted: 4 Sep 2013 Last revised: 21 Jun 2016

Bruno Feunou

Bank of Canada

Jean-Sebastien Fontaine

Bank of Canada

Date Written: December 17, 2015

Abstract

Cochrane and Piazzesi (2005) show that (i) lagged forward rates help predict bond returns and that (ii) modern Markovian dynamic term structure models (DTSMs) cannot match the evidence. We develop the family of Conditional Mean DTSMs where the dynamics depend on current yields and their history through a moving-average component. Our preferred Conditional Mean model combines one moving-average with the usual three Gaussian risk factors, closely matches the bond risk premium measured from predictive regressions and provides better forecasts of bond returns. Our framework nests Duffee (2011) models with a small “hidden” factor and our results compare favorably with his 5-factor model. Conditional Mean models are easier to estimate than state-space term structure based on Kalman estimates of latent factors.

Keywords: term structure models, bond risk premia, Markovian dynamics, Kalman filter

JEL Classification: E43, E47, G12

Suggested Citation

Feunou, Bruno and Fontaine, Jean-Sebastien, Bond Risk Premia and Gaussian Term Structure Models (December 17, 2015). Forthcoming, Management Science. Available at SSRN: https://ssrn.com/abstract=2320123 or http://dx.doi.org/10.2139/ssrn.2320123

Bruno Feunou

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada
613-782-8302 (Phone)

HOME PAGE: http://kamkui.net/

Jean-Sebastien Fontaine (Contact Author)

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

HOME PAGE: http://www.jean-sebastienfontaine.com

Paper statistics

Downloads
208
Rank
123,742
Abstract Views
1,125