Understanding bond risk premia

Pavol Povala and Anna Cieslak
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Anna Cieslak: Northwestern University

No 771, 2012 Meeting Papers from Society for Economic Dynamics

Abstract: We decompose yields into long-horizon expected inflation and maturity-related cycles to study the predictability of bond excess returns. Cycles capture the risk premium and the business cycle variation of short rate expectations. From cycles, we construct a forecasting factor that explains up to above 50% (30%) of in-sample (out-of-sample) variation of annual bond returns. The factor varies at a frequency higher than the business cycle, and predicts real activity at long horizons. It also aggregates information from different macro-finance predictors of bond returns. Our decomposition reveals why bond returns are predictable by a linear combination of forward rates or the term spread.

Date: 2012
New Economics Papers: this item is included in nep-for and nep-upt
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Citations: View citations in EconPapers (14)

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Persistent link: https://EconPapers.repec.org/RePEc:red:sed012:771

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