Fiscal Policy Driven Bond Risk Premia

100 Pages Posted: 15 Sep 2016 Last revised: 10 Apr 2019

See all articles by Lorenzo Bretscher

Lorenzo Bretscher

London Business School - Department of Finance; affiliation not provided to SSRN

Alex Hsu

Georgia Institute of Technology - Scheller College of Business

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick; London School of Economics & Political Science (LSE)

Date Written: April 6, 2019

Abstract

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

Bretscher, Lorenzo and Hsu, Alex and Tamoni, Andrea, Fiscal Policy Driven Bond Risk Premia (April 6, 2019). Available at SSRN: https://ssrn.com/abstract=2838667 or http://dx.doi.org/10.2139/ssrn.2838667

Lorenzo Bretscher

London Business School - Department of Finance ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

affiliation not provided to SSRN

Alex Hsu

Georgia Institute of Technology - Scheller College of Business ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States
4043851123 (Phone)

Andrea Tamoni (Contact Author)

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
02079557303 (Phone)

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