Bond Risk Premiums at the Zero Lower Bound
43 Pages Posted: 25 Jul 2019 Last revised: 21 Oct 2019
Date Written: 2019-05-28
This paper documents a significantly stronger relationship between the slope of the yield curve and future excess bond returns on Treasuries from 2008-2015 than before 2008. This new predictability result is not matched by the standard shadow rate model with Gaussian factor dynamics, but extending the model with regime-switching in the (physical) dynamics of the factors at the lower bound resolves this shortcoming. The model is also consistent with the downwards trend in surveys on short rate expectations at long horizons, but requires a break in the level of its factors to closely fit the low level of these surveys since 2015.
Keywords: Dynamic Term Structure Model, Bond Return Predictability, Regime-Switching, Shadow Rate Model, Structural Break
JEL Classification: G12, E43, E44
Suggested Citation: Suggested Citation