A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets

Ravi Bansal and Ivan Shaliastovich

No 18357, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We show that bond risk-premia rise with uncertainty about expected inflation and fall with uncertainty about expected growth; the magnitude of return predictability using these two uncertainty measures is similar to that by multiple yields. Motivated by this evidence, we develop and estimate a long-run risks model with time-varying volatilities of expected growth and inflation. The model simultaneously accounts for bond return predictability and violations of uncovered interest parity in currency markets. We find that preference for early resolution of uncertainty, time-varying volatilities, and non-neutral effects of inflation on growth are important to account for these aspects of asset markets.

JEL-codes: E0 F0 F3 F31 G0 G1 (search for similar items in EconPapers)
Date: 2012-09
New Economics Papers: this item is included in nep-fdg, nep-mac and nep-upt
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Published as Ravi Bansal & Ivan Shaliastovich, 2013. "A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets," Review of Financial Studies, vol 26(1), pages 1-33.

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Journal Article: A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets (2013)
Working Paper: A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets (2012)
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