Fiscal Policy Driven Bond Risk Premia
100 Pages Posted: 15 Sep 2016 Last revised: 10 Apr 2019
Date Written: April 6, 2019
Fiscal policy matters for bond risk premia. Empirically, government spending level and volatility predict excess bond returns. Shocks to government spending level and volatility are also priced in the cross-section of bond and stock portfolios. Theoretically, level shocks raise inflation when marginal utility is high, thus generating positive inflation risk premia (term structure level effect). Volatility shocks steepen the yield curve (slope effect), producing positive term premia. These effects are consistent with evidence from a structural VAR. Further, asset pricing tests using model simulated data corroborate our empirical findings. Lastly, fiscal shocks are amplified at the zero lower bound.
Keywords: Bond Risk Premia, Fiscal Policy, Uncertainty
JEL Classification: G12, E62
Suggested Citation: Suggested Citation