Macroeconomic Sources of Risk in the Term Structure

49 Pages Posted: 26 Nov 2004

See all articles by Michael Wickens

Michael Wickens

University of York; Cardiff Business School; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Hiona Balfoussia

Bank of Greece

Date Written: November 2004

Abstract

In this paper we develop a new way of modelling time variation in term premia. This is based on the stochastic discount factor model of asset pricing with observable macroeconomic factors. The joint distribution of excess holding period US bond returns of different maturity and the fundamental macroeconomic factors is modelled using multivariate GARCH with conditional covariances in the mean to capture the term premia. We show how by testing the assumption of no arbitrage we can derive a specification test of our model. We estimate the contribution made to the term premia at different maturities by real and nominal macroeconomic sources of risk. From the estimated term premia we recover the term structure of interest rates and examine how it varies through time. Finally, we examine whether the large number of reported failures of the rational expectations hypothesis of the term structure can be attributed to an omitted time-varying term premium.

Keywords: term structure, the stochastic discount factor model, term premia, GARCH

JEL Classification: C5, E4, G1

Suggested Citation

Wickens, Michael and Balfoussia, Hiona, Macroeconomic Sources of Risk in the Term Structure (November 2004). Available at SSRN: https://ssrn.com/abstract=625941

Michael Wickens (Contact Author)

University of York ( email )

Heslington
York, YO10 5DD
United Kingdom
+44 1904 433 764 (Phone)
+44 1904 433 575 (Fax)

Cardiff Business School ( email )

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Hiona Balfoussia

Bank of Greece ( email )

21 E. Venizelos Avenue
GR-10250 Athens
Greece

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