Bond Risk Premia, Macroeconomic Factors and Financial Crisis in the Euro Area
Louvain School of Management Working Paper Series No. 2015/14
89 Pages Posted: 9 Oct 2015
Date Written: June 15, 2015
This paper investigates the power of macroeconomic factors to explain euro area bond risk premia using (i) a big dataset (ii) the Elastic Net variable selection. We find that macroeconomic factors, in particular economic activity and sentiment indicators, explain 40% of the variability of risk premia before the crisis, and up to 55% during the financial crisis, and both for core countries (from 40% to 60%) and periphery countries (from 35% to 44%). Moreover, macroeconomic factor models clearly outperform financial indicators like the CP-factor and credit default swap (CDS) premia, even in periods of significant market turbulence.
Keywords: Bond risk premium, Macro Factors, Financial Crisis, Model Selection, Variable Selection
JEL Classification: E43, E44, G01, G12, C52, C55
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