Macro Strikes Back: Term Structure of Risk Premia

Abstract

We develop a novel framework that sharply identifies the shocks common to financial markets and the macroeconomy, their propagation across horizons, and the term structure of macro risk premia. We find that macro factors’ risk premia are strongly time-varying and countercyclical, with sharply increasing unconditional term structures. Macro risk premia are small and negligible in the short run, yet grow to match the magnitude of equity risk premia at the business cycle horizon—in a nutshell, we reconnect macro to finance. As we show, this pattern is driven by the slow propagation of almost interchangeable priced shocks that capture most of the persistence in macroeconomic variables. Crucially, it is not mechanically due to factor persistence: while GDP, consumption, industrial production, hours worked, and employment exhibit upward-sloping term structures, other similarly persistent factors—such as the VIX or intermediary-based variables—display downward-sloping or flat ones. 

Keywords: Macro-finance, asset pricing, risk premia, linear factor models, Bayesian inference, term structures, C58, E27, E44, G12, G17

JEL Classification: C11, C58, E27, E44, G12, G17