Predicting Bond Return Predictability
108 Pages Posted: 30 Jan 2020 Last revised: 13 Apr 2020
Date Written: April 12, 2020
We document predictable shifts in bond return predictability using a new test for equal conditional predictive ability among multiple forecasting methods. Bond returns are predictable in high (low) economic activity (uncertainty) states, implying that the expectations hypothesis of the term structure holds periodically. These predictable performance differences can be used in real-time to improve out-of-sample bond risk premia estimates and investors’ economic value by means of a novel and dynamic forecast combination scheme. Consistent with standard financial theory, the resulting forecast are strongly countercyclical and peaks in recessions. The empirical findings can be recovered in a non-linear term structure model.
Keywords: bond excess returns, forecasting, state-dependencies, multivariate test, equal conditional predictive ability
JEL Classification: C12, C52, E43, E44, G12
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