The Price and Quantity of Interest Rate Risk

35 Pages Posted: 21 Nov 2020

See all articles by Jennifer N. Carpenter

Jennifer N. Carpenter

New York University (NYU) - Department of Finance

Fangzhou Lu

The University of Hong Kong - Department of Finance; Massachusetts Institute of Technology (MIT) - Sloan School of Management

Robert Whitelaw

New York University; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: October 3, 2020

Abstract

Studies of time-varying government bond risk premia that do not account for corresponding time variation in bond risk are incomplete. This paper provides evidence that (1) bond risk premia are solely compensation for bond risk, as no-arbitrage theory predicts, (2) both bond return volatility and the price of that risk vary stochastically, and (3) there is an important time-varying second factor in expected returns. We estimate the joint dynamics of the volatility and the Sharpe ratio of returns on the first and second principal-component bond-factor portfolios in both the US and China. In all four cases, volatility dynamics play a fundamental role in the dynamics of risk premia, and bond factor Sharpe ratios vary stochastically. In the US, VIX is a significant predictor of bond factor volatility and price of risk, incremental to yield-curve level, slope, and curvature.

Keywords: bond risk premia, bond Sharpe ratios, interest rate volatility, US Treasury bonds, Chinese government bonds, no arbitrage, principal components analysis

JEL Classification: G12, G15

Suggested Citation

Carpenter, Jennifer N. and Lu, Fangzhou and Whitelaw, Robert F., The Price and Quantity of Interest Rate Risk (October 3, 2020). NYU Stern School of Business Forthcoming, Available at SSRN: https://ssrn.com/abstract=3682888 or http://dx.doi.org/10.2139/ssrn.3682888

Jennifer N. Carpenter (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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New York, NY 10012-1126
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Fangzhou Lu

The University of Hong Kong - Department of Finance ( email )

Pokfulam
Hong Kong

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Robert F. Whitelaw

New York University ( email )

Stern School of Business
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New York, NY 10012-1126
United States
212-998-0338 (Phone)
212-995-4233 (Fax)

National Bureau of Economic Research (NBER)

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