41 Pages Posted: 3 Mar 2014
Date Written: March 1, 2014
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: 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