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

Andrea Berardi, Michael Markovich, Alberto Plazzi and Andrea Tamoni
Additional contact information
Andrea Berardi: Ca Foscari University of Venice - Dipartimento di Economia
Michael Markovich: Investment Strategy - Private Banking Wealth Management; Vienna Institute of Finance
Andrea Tamoni: Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick; London School of Economics & Political Science (LSE)

No 19-52, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: We show that the difference between the natural rate of interest and the current level of monetary policy stance, dubbed Convergence Gap (CG), contains information that is valuable for bond predictability. Adding CG in forecasting regressions of bond excess returns significantly raises the R-squared, and restores countercyclical variation in bond risk premia that is otherwise missed by forward rates. The convergence gap also predicts changes in future yields, and consistently plays the role of an unspanned variable within an affine term structure framework. The importance of the gap remains robust out-of-sample, and in countries other than the U.S. 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)
JEL-codes: E0 E43 G0 G12 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2019-09
New Economics Papers: this item is included in nep-for and nep-mac
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Journal Article: Mind the (Convergence) Gap: Bond Predictability Strikes Back! (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1952

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