Time to Build and Bond Risk Premia

42 Pages Posted: 28 Nov 2020

See all articles by Bin Guo

Bin Guo

Nankai University - School of Finance

Fuzhe Huang

Nankai University

Kai Li

Macquarie Business School, Macquarie University

Date Written: October 10, 2020


This paper studies the impact of time to build on the term structure of interest rates in an otherwise standard Cox, Ingersoll and Ross (1985a, 1985b, CIR) production economy. Due to time to build, production depends not only on the current business condition as in the original CIR, but also on past conditions over the production period. This causes equilibrium quantities, including the short rate, forward rates, and bond returns, to depend on the historical path of the production opportunities. Production delay that accumulates uncertainty over the time to build generates significant time variations in bond risk premia. Bond returns can be predicted by current forward rates, as well as their lagged values, since current market states not only affect the current short rate but also the short rate in a distant future. Due to the path dependence, risk premia cannot be fully spanned by current yields. We show that time to build improves the ability of the CIR in generating empirical facts.

Keywords: Time to build, CIR model, bond risk premia, path dependence, Non- Markovian asset pricing, stochastic delay differential equations.

JEL Classification: D51, E43, G12

Suggested Citation

Guo, Bin and Huang, Fuzhe and Li, Kai, Time to Build and Bond Risk Premia (October 10, 2020). Available at SSRN: https://ssrn.com/abstract=3709118 or http://dx.doi.org/10.2139/ssrn.3709118

Bin Guo

Nankai University - School of Finance ( email )

38 Tongyan Road, Jinnan District
Tianjin, Tianjin 300350

Fuzhe Huang

Nankai University ( email )

94 Weijin Road
Tianjin, 300071

Kai Li (Contact Author)

Macquarie Business School, Macquarie University ( email )

Level 6 4 Eastern Road, Macquarie University
North Ryde NSW 2109
Sydney, NSW 99999
435473800 (Phone)

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