Bond Return Predictability: Economic Value and Links to the Macroeconomy

Davide Pettenuzzo (), Antonio Gargano and Allan Timmermann
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Antonio Gargano: University of Melbourne
Allan Timmermann: University of California San Diego

No 75R, Working Papers from Brandeis University, Department of Economics and International Business School

Abstract: Studies of bond return predictability find a puzzling disparity between strong statistical evidence of return predictability and the failure to convert return forecasts into economic gains. We show that resolving this puzzle requires accounting for important features of bond return models such as time varying parameters, volatility dynamics, and unspanned macro factors. A three-factor model comprising the Fama and Bliss (1987) forward spread, the Cochrane and Piazzesi (2005) combination of forward rates and the Ludvigson and Ng (2009) macro factor generates notable gains in out-of-sample forecast accuracy compared with a model based on the expectations hypothesis. Such gains in predictive accuracy translate into higher risk-adjusted portfolio returns after accounting for estimation error and model uncertainty. Consistent with models featuring unspanned macro factors, our forecasts of future bond excess returns are strongly negatively correlated with survey forecasts of short rates.

Keywords: bond returns; yield curve; macro factors; stochastic volatility; time-varying parameters; unspanned macro risk factors. (search for similar items in EconPapers)
JEL-codes: G11 G12 G17 (search for similar items in EconPapers)
Pages: 59 pages
Date: 2014-07, Revised 2016-07
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Citations: View citations in EconPapers (1)

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http://www.brandeis.edu/economics/RePEc/brd/doc/Brandeis_WP75R.pdf First version, 2014 (application/pdf)

Related works:
Journal Article: Bond Return Predictability: Economic Value and Links to the Macroeconomy (2019)
Working Paper: Bond Return Predictability: Economic Value and Links to the Macroeconomy (2014)
Working Paper: Bond Return Predictability: Economic Value and Links to the Macroeconomy (2014)
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