Ex ante bond returns and time-varying monotonicity

Hamid Yahyaei, Abhay Singh and Tom Smith

Journal of International Financial Markets, Institutions and Money, 2025, vol. 99, issue C

Abstract: We examine the dynamics of U.S. Treasury term premia by applying and extending the nonparametric framework of Boudoukh, Richardson, Smith, and Whitelaw (1999) into a time-varying test of monotonicity. The framework exploits conditioning variables with economic relevance to the business cycle, which a priori predict non-monotonic Treasury returns to permit a formal test of the Liquidity Preference Hypothesis (LPH). Conditioning ex ante returns against inversion in the yield curve, restrictive monetary policy rates, and negative investor sentiment reveals a non-monotonic term premium on Treasury bills. In contrast, term premia on portfolios comprising longer-term Treasury notes are primarily monotonic but exhibit non-monotonicity that coincides with unexpected macroeconomic shocks. When interest rates reach the zero lower bound, term premia are universally monotonic, demonstrating the Federal Reserve’s ability to normalise the yield curve. Ultimately, we illustrate the importance of accounting for the time-varying behaviour of the term premium, especially as changes in the business cycle influence the term structure of interest rates.

Keywords: Liquidity Preference Hypothesis; Monotonicity; Term Structure; Yield Curve (search for similar items in EconPapers)
JEL-codes: C14 E43 E52 E58 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:99:y:2025:i:c:s1042443125000046

DOI: 10.1016/j.intfin.2025.102114

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