Expectations and Risk Premia at 8:30am: Deciphering the Responses of Bond Yields to Macroeconomic Announcements

51 Pages Posted: 27 Dec 2017

See all articles by Peter Hördahl

Peter Hördahl

Bank for International Settlements (BIS) - BIS Representative Office for Asia and the Pacific

Eli M. Remolona

Bank for International Settlements (BIS) - Monetary and Economic Department

Giorgio Valente

Hong Kong Institute for Monetary and Financial Research (HKIMR)

Date Written: December 20, 2017

Abstract

What explains the sharp movements of the yield curve in response to major U.S. macroeconomic announcements? To answer this question, we estimate an arbitrage-free dynamic term structure model with macroeconomic fundamentals as risk factors. We assume that the yield curve reacts to announcements primarily because of the information these contain about the fundamentals of output,inflation and the Fed’s inflation target. We model the updating process by linking the factor shocks to announcement surprises. Fitting this process to data on yield curve movements in 20-minute event windows, we find that most major announcements, especially those concerning the labor market, are informative largely about the output gap rather than inflation. The resulting changes in short-rate expectations account for the bulk of observed yield movements. But adjustments in risk premia are also sizable. In partly offsetting the effects of short-rate expectations, these adjustments help to account for the well-known hump-shaped pattern of yield reactions across maturities.

Keywords: affine models, bond excess returns, economic announcements, term structure of interest rates

JEL Classification: G0, G1, E0, E4

Suggested Citation

Hoerdahl, Peter and Remolona, Eli M. and Valente, Giorgio, Expectations and Risk Premia at 8:30am: Deciphering the Responses of Bond Yields to Macroeconomic Announcements (December 20, 2017). Available at SSRN: https://ssrn.com/abstract=3091428 or http://dx.doi.org/10.2139/ssrn.3091428

Peter Hoerdahl (Contact Author)

Bank for International Settlements (BIS) - BIS Representative Office for Asia and the Pacific ( email )

78th floor, Two International Finance Centre
8 Finance Street, Central
Hong Kong

Eli M. Remolona

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

IFC 2 Bldg, 78/F
Central
Hong Kong
Hong Kong
+852 2982 7150 (Phone)
+852 2982 7123 (Fax)

Giorgio Valente

Hong Kong Institute for Monetary and Financial Research (HKIMR) ( email )

One Pacific Place, 10th Floor
88 Queensway
Hong Kong
China

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