Mind the (Convergence) Gap: Bond Predictability Strikes Back!

Andrea Berardi (), Michael Markovich (), Alberto Plazzi and Andrea Tamoni ()
Additional contact information
Andrea Berardi: Department of Economics, Università Ca’ Foscari Venezia, Venezia 30121, Italy
Michael Markovich: Quantitative Investment Office, Zurich 8802, Switzerland
Andrea Tamoni: Department of Finance, Rutgers Business School, Newark, New Jersey 07102

Management Science, 2021, vol. 67, issue 12, 7888-7911

Abstract: We show that the difference between the natural rate of interest and the current level of monetary policy stance, which we label Convergence Gap (CG), contains information that is valuable for bond predictability. Adding CG in forecasting regressions of bond excess returns significantly raises the R 2 , and restores countercyclical variation in bond risk premia that is otherwise missed by forward rates. Consistent with the argument that CG captures the effect of real imbalances on the path of rates, our factor has predictive ability for real bond excess returns. The importance of the gap remains robust out-of-sample and in countries other than the United States. Furthermore, its inclusion brings significant economic gains in the context of dynamic conditional asset allocation.

Keywords: bond risk premia; forward rates; monetary policy; natural rate of interest; bond predictability (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (1)

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http://dx.doi.org/10.1287/mnsc.2020.3847 (application/pdf)

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Working Paper: Mind the (Convergence) Gap: Bond Predictability Strikes Back! (2019)
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