Regime Shifts and Bond Returns

Jacob Boudoukh, Matthew Richardson, Tom Smith and Robert Whitelaw

New York University, Leonard N. Stern School Finance Department Working Paper Seires from New York University, Leonard N. Stern School of Business-

Abstract: This paper investigates the implications of a 2-regime model of the business cycle for term premiums and volatilities in the bond market. The model, which is estimated via maximum likelihood using GDP, consumption and production data, has two key features -- mean growth rates that vary across regimes and time-varying transition probabilities between regimes. The implied dynamics of term premiums and volatilities are complex and interesting. Business cycle turning points are characterized by high volatility and strongly time-varying term premiums. These implications are then investigated using data on bond returns. Nonparametric estimation results are broadly consistent with the model. Using the slope of the term structure as a conditioning variable, we can identify periods with negative term premiums and volatile returns.

Date: 1999-11-01
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Persistent link: https://EconPapers.repec.org/RePEc:fth:nystfi:99-010

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