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Bond Risk Premia

45 Pages Posted: 15 Sep 2002 Last revised: 29 Oct 2010

John H. Cochrane

Hoover Institution; National Bureau of Economic Research (NBER); University of Chicago - Booth School of Business

Monika Piazzesi

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Date Written: September 2002

Abstract

This paper studies time variation in expected excess bond returns. We run regressions of annual excess returns on forward rates. We find that a single factor predicts 1-year excess returns on 1-5 year maturity bonds with an R2 up to 43%. The single factor is a tent-shaped linear function of forward rates. The return forecasting factor has a clear business cycle correlation: Expected returns are high in bad times, and low in good times, and the return-forecasting factor forecasts long-run output growth. The return-forecasting factor also forecasts stock returns, suggesting a common time-varying premium for real interest rate risk. The return forecasting factor is poorly related to level, slope, and curvature movements in bond yields. Therefore, it represents a source of yield curve movement not captured by most term structure models. Though the return-forecasting factor accounts for more than 99% of the time-variation in expected excess bond returns, we find additional, very small factors that forecast equally small differences between long term bond returns, and hence statistically reject a one-factor model for expected returns.

Suggested Citation

Cochrane, John H. and Piazzesi, Monika, Bond Risk Premia (September 2002). NBER Working Paper No. w9178. Available at SSRN: https://ssrn.com/abstract=330317

John H. Cochrane (Contact Author)

Hoover Institution ( email )

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HOME PAGE: http://faculty.chicagobooth.edu/john.cochrane/index.htm

National Bureau of Economic Research (NBER)

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University of Chicago - Booth School of Business ( email )

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HOME PAGE: http://faculty.chicagobooth.edu/john.cochrane/research/Papers/

Monika Piazzesi

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-834-3199 (Phone)
773-702-0458 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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