Macro-finance VARs and bond risk premia: a caveat

Marco Taboga

MPRA Paper from University Library of Munich, Germany

Abstract: Around the turn of the Twentieth century, US and euro area long-term bond yields experienced a remarkable decline and remained at historically low levels even in the face of rising short-term rates (the so called "conundrum"). This unusual phenomenon has been analyzed by many researchers through the lens of macro-finance VARs and no-arbitrage term structure models. A commonly found result is that the decline in long-term rates was primarily driven by an unprecedented reduction in risk premia. I show that such result might be an artefact of the class of models employed to study the phenomenon. I propose an alternative model which suggests that, although risk premia played an important role in reducing bond yields, other two equally important forces were at play, i.e. a decline in the real natural rate of interest and a structural reduction in inflation expectations. I conclude that, after accounting for permanent shifts in the expectations about the future path of short-term rates, the dynamics of risk premia observed after the turn of the century have not been unusual if considered from an historical perspective.

Keywords: Bond yields; forward premia; macro-finance models (search for similar items in EconPapers)
JEL-codes: C32 E0 G12 (search for similar items in EconPapers)
Date: 2008-11-14
New Economics Papers: this item is included in nep-fmk, nep-mac and nep-mon
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Journal Article: Macro-finance VARs and bond risk premia: A caveat (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:11585

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