Macro Risks and the Term Structure of Interest Rates

76 Pages Posted: 5 Jun 2017

See all articles by Geert Bekaert

Geert Bekaert

Columbia Business School - Finance and Economics

Eric Engstrom

U.S. Board of Governors of the Federal Reserve System - Division of Research and Statistics, Capital Markets

Andrey Ermolov

Fordham University - Gabelli School of Business

Multiple version iconThere are 4 versions of this paper

Date Written: 2017-06

Abstract

We use non-Gaussian features in U.S. macroeconomic data to identify aggregate supply and demand shocks while imposing minimal economic assumptions. Recessions in the 1970s and 1980s were driven primarily by supply shocks, later recessions were driven primarily by demand shocks, and the Great Recession exhibited large negative shocks to both demand and supply. We estimate "macro risk factors" that drive "bad" (negatively skewed) and "good" (positively skewed) variation for supply and demand shocks. The Great Moderation is mostly accounted for by a reduction in good variance. In contrast, bad variances for both supply and demand shocks, which account for most recessions, shows no secular decline. We document that macro risks significantly contribute to the variation yields, risk premiums and return variances for nominal bonds. While overall bond risk premiums are counter-cyclical, an increase in demand variance lowers risk premiums.

Keywords: Bond return predictability, Business cycle, Great moderation, Macroeconomic volatility, Term premium

JEL Classification: E31, E32, E43, E44, G12, G13

Suggested Citation

Bekaert, Geert and Engstrom, Eric C. and Ermolov, Andrey, Macro Risks and the Term Structure of Interest Rates (2017-06). FEDS Working Paper No. 2017-058. Available at SSRN: https://ssrn.com/abstract=2979914 or http://dx.doi.org/10.17016/FEDS.2017.058

Geert Bekaert

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Eric C. Engstrom (Contact Author)

U.S. Board of Governors of the Federal Reserve System - Division of Research and Statistics, Capital Markets ( email )

20th & C. St., N.W.
Washington, DC 20551
United States
202-452-3044 (Phone)

Andrey Ermolov

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
Bronx, NY 10458
United States
9179690060 (Phone)

HOME PAGE: http://faculty.fordham.edu/aermolov1/

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