Expectation Puzzles, Time-Varying Risk Premia, and Dynamic Models of the Term Structure

33 Pages Posted: 16 Mar 2001 Last revised: 5 Oct 2001

See all articles by Qiang Dai

Qiang Dai

University of North Carolina (UNC) at Chapel Hill - Finance Area

Kenneth J. Singleton

Stanford University - Graduate School of Business

Date Written: March 2001

Abstract

Though linear projections of returns on the slope of the yield curve have contradicted the implications of the traditional expectations theory,' we show that these findings are not puzzling relative to a large class of richer dynamic term structure models. Specifically, we are able to match all of the key empirical findings reported by Fama and Bliss and Campbell and Shiller, among others, within large subclasses of affine and quadratic-Gaussian term structure models. Additionally, we show that certain risk-premium adjusted' projections of changes in yields on the slope of the yield curve recover the coefficients of unity predicted by the models. Key to this matching are parameterizations of the market prices of risk that let the risk factors affect the market prices of risk directly, and not only through the factor volatilities. The risk premiums have a simple form consistent with Fama's findings on the predictability of forward rates, and are shown to also be consistent with interest rate, feedback rules used by a monetary authority in setting monetary policy.

Suggested Citation

Dai, Qiang and Singleton, Kenneth J., Expectation Puzzles, Time-Varying Risk Premia, and Dynamic Models of the Term Structure (March 2001). NBER Working Paper No. w8167. Available at SSRN: https://ssrn.com/abstract=263429

Qiang Dai (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Finance Area ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-7182 (Phone)

Kenneth J. Singleton

Stanford University - Graduate School of Business ( email )

Knight Management Center
655 Knight Way
Stanford, CA 94305-7298
United States
650-723-5753 (Phone)

HOME PAGE: http://www.stanford.edu/~kenneths

Register to save articles to
your library

Register

Paper statistics

Downloads
63
Abstract Views
3,179
rank
346,218
PlumX Metrics