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Bond Market Exposures to Macroeconomic and Monetary Policy Risks

Dongho Song

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: I provide empirical evidence of changes in the U.S. Treasury yield curve and related macroeconomic factors, and investigate whether the changes are brought about by external shocks, monetary policy, or by both. To explore this, I characterize bond market exposures to macroeconomic and monetary policy risks, using an equilibrium term structure model with recursive preferences in which inflation dynamics are endogenously determined. In my model, the key risks that affect bond market prices are changes in the correlation between growth and inflation and changes in the conduct of monetary policy. Using a novel estimation technique, I find that the changes in monetary policy affect the volatility of yield spreads, while the changes in the correlation between growth and inflation affect both the level as well as the volatility of yield spreads. Consequently, the changes in the correlation structure are the main contributor to bond risk premia and to bond market volatility. The time variations within a regime and risks associated with moving across regimes lead to the failure of the Expectations Hypothesis and to the excess bond return predictability regression of Cochrane and Piazzesi (2005), as in the data.

Keywords: Monetary Policy Risks; Regime-Switching Macroeconomic Risks; Stochastic Volatility; Taylor-Rule; Term Structure (search for similar items in EconPapers)
JEL-codes: E43 G12 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2014-04-30
New Economics Papers: this item is included in nep-cba, nep-fmk, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (20)

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Related works:
Journal Article: Bond Market Exposures to Macroeconomic and Monetary Policy Risks (2017) Downloads
Working Paper: Bond Market Exposures to Macroeconomic and Monetary Policy Risks (2016) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:pen:papers:14-017

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