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Risk and Return Trade-Off in the U.S. Treasury Market

41 Pages Posted: 3 Mar 2014  

Eric Ghysels

University of North Carolina Kenan-Flagler Business School; University of North Carolina (UNC) at Chapel Hill - Department of Economics

Anh Le

University of North Carolina Kenan-Flagler Business School

Sunjin Park

University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Date Written: March 1, 2014

Abstract

This paper characterizes the risk-return trade-off in the U.S. Treasury market. We propose a discrete-time no-arbitrage term structure model, in which bond prices are solved in closed form and the conditional variances of bond yields are decomposed into a short-run component and a long-run component, each of which follows a GARCH-type process. Estimated using Treasury yields data from January 1962 to August 2007, our model simultaneously matches the conditional volatility dynamics and the deviation from the expectations hypothesis in the data. We find that a higher short-run volatility component of bond yields significantly predicts a higher future excess return, above and beyond the predictive power of the yields. The long-run volatility component does not predict bond excess returns.

Keywords: bond risk premium, stochastic volatility, term structure models

JEL Classification: G12, C58

Suggested Citation

Ghysels, Eric and Le, Anh and Park, Sunjin and Zhu, Haoxiang, Risk and Return Trade-Off in the U.S. Treasury Market (March 1, 2014). Available at SSRN: https://ssrn.com/abstract=2403483 or http://dx.doi.org/10.2139/ssrn.2403483

Eric Ghysels

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Gardner Hall, CB 3305
Chapel Hill, NC 27599
United States
919-966-5325 (Phone)
919-966-4986 (Fax)

HOME PAGE: http://www.unc.edu/~eghysels/

Anh Le (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States

Sunjin Park

University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States

Haoxiang Zhu

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street E62-623
Cambridge, MA 02142
United States

HOME PAGE: http://www.mit.edu/~zhuh

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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