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Macro Risks and the Term Structure of Interest Rates

Geert Bekaert (), Eric Engstrom and Andrey Ermolov

No 2017-058, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

Abstract: We use non-Gaussian features in U.S. macroeconomic data to identify aggregate supply and demand shocks while imposing minimal economic assumptions. Recessions in the 1970s and 1980s were driven primarily by supply shocks, later recessions were driven primarily by demand shocks, and the Great Recession exhibited large negative shocks to both demand and supply. We estimate "macro risk factors" that drive "bad" (negatively skewed) and "good" (positively skewed) variation for supply and demand shocks. The Great Moderation is mostly accounted for by a reduction in good variance. In contrast, bad variances for both supply and demand shocks, which account for most recessions, shows no secular decline. We document that macro risks significantly contribute to the variation yields, risk premiums and return variances for nominal bonds. While overall bond risk premiums are counter-cyclical, an increase in demand variance lowers risk premiums.

Keywords: Bond return predictability; Business cycle; Great moderation; Macroeconomic volatility; Term premium (search for similar items in EconPapers)
JEL-codes: E31 E32 E43 E44 G12 G13 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac and nep-mon
Date: 2017-06
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Working Paper: Macro Risks and the Term Structure of Interest Rates (2016) Downloads
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