Bond risk premia, priced regime shifts, and macroeconomic fundamentals

Constantino Hevia, Martin Sola and Ivan Petrella

Department of Economics Working Papers from Universidad Torcuato Di Tella

Abstract: In this paper, we develop and estimate an arbitrage-free model of bond prices in which the evolution of the risk factors and the parameters of the stochastic discount factor are subject to occasional discrete changes in regimes. We show that the component of risk premia associated with regime shifts is related to the macroeconomic environment. In particular, the explicit pricing of regime shifts and the nonlinearities associated with the Markov switching model generates a strong connection between bond risk premia and the macroeconomy as summarized by variables such as inflation, industrial production, and unemployment.

Keywords: Bubbles; Explosiveness; Markov-switching autoregressive model; Unit-root test. (search for similar items in EconPapers)
JEL-codes: C13 C22 E43 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2022-09
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Related works:
Working Paper: Bond Risk Premia, Priced Regime Shifts, and Macroeconomic Fundamentals (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:udt:wpecon:2022_03

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