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49
Risk Premiums in Dynamic Term Structure Models with . . .
, 2010
"... This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. To accomplish this we develop a novel arbitragefree DT SM in which macroeconomic risks – in particular, real output and ..."
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Cited by 66 (10 self)
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This paper quantifies how variation in real economic activity and inflation in the U.S. influenced the market prices of level, slope, and curvature risks in U.S. Treasury markets. To accomplish this we develop a novel arbitragefree DT SM in which macroeconomic risks – in particular, real output and inflation risks – impact bond investment decisions separately from information about the shape of the yield curve. Estimates of our preferred macroDT SM over the twentythree year period from 1985 through 2007 reveal that unspanned macro risks explained a substantial proportion of the variation in forward terms premiums. Unspanned macro risks accounted for nearly 90 % of the conditional variation in shortdated forward term premiums, with unspanned real economic growth being the key driving factor. Over horizons beyond three years, these effects were entirely attributable to unspanned inflation. Using our model, we also reassess some of Chairman Bernanke’s remarks on the interplay between term premiums, the shape of the yield curve, and macroeconomic activity.
Macro factors in bond risk premia
 Review of Financial Studies
, 2009
"... Are there important cyclical fluctuations in bond market premiums and, if so, with what macroeconomic aggregates do these premiums vary? We use the methodology of dynamic factor analysis for large datasets to investigate possible empirical linkages between forecastable variation in excess bond retur ..."
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Cited by 61 (1 self)
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Are there important cyclical fluctuations in bond market premiums and, if so, with what macroeconomic aggregates do these premiums vary? We use the methodology of dynamic factor analysis for large datasets to investigate possible empirical linkages between forecastable variation in excess bond returns and macroeconomic fundamentals. We find that “real ” and “inflation ” factors have important forecasting power for future excess returns on U.S. government bonds, above and beyond the predictive power contained in forward rates and yield spreads. This behavior is ruled out by commonly employed affine term structure models where the forecastability of bond returns and bond yields is completely summarized by the crosssection of yields or forward rates. An important implication of these findings is that the cyclical behavior of estimated risk premia in both returns and longterm yields depends importantly on whether the information in macroeconomic factors is included in forecasts of excess bond returns. Without the macro factors, risk premia appear virtually acyclical, whereas with the estimated factors risk premia have a marked countercyclical component, consistent with theories that imply investors must be compensated for risks associated with macroeconomic activity. ( JEL E0, E4, G10, G12) 1.
The Term Structures of Equity and Interest Rates
, 2007
"... This paper proposes a dynamic riskbased model capable of jointly explaining the term structure of interest rates, returns on the aggregate market and the risk and return characteristics of value and growth stocks. Both the term structure of interest rates and returns on value and growth stocks conv ..."
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Cited by 39 (6 self)
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This paper proposes a dynamic riskbased model capable of jointly explaining the term structure of interest rates, returns on the aggregate market and the risk and return characteristics of value and growth stocks. Both the term structure of interest rates and returns on value and growth stocks convey information about how the representative investor values cash flows of different maturities. We model how the representative investor perceives risks of these cash flows by specifying a parsimonious stochastic discount factor for the economy. Shocks to dividend growth, the real interest rate, and expected inflation are priced, but shocks to the price of risk are not. Given reasonable assumptions for dividends and inflation, we show that the model can simultaneously account for the behavior of aggregate stock returns, an upwardsloping yield curve, the failure of the expectations hypothesis and the poor performance of the capital asset pricing model.
Fiscal Policy and the Term Structure of Interest Rates
, 2004
"... Macroeconomists want to understand the effects of fiscal policy on interest rates, while financial economists look for the factors that drive the dynamics of the yield curve. To shed light on both issues, we present an empirical macrofinance model that combines a noarbitrage affine term structure m ..."
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Cited by 34 (3 self)
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Macroeconomists want to understand the effects of fiscal policy on interest rates, while financial economists look for the factors that drive the dynamics of the yield curve. To shed light on both issues, we present an empirical macrofinance model that combines a noarbitrage affine term structure model with a set of structural restrictions that allow us to identify fiscal policy shocks, and trace the effects of these shocks on the prices of bonds of different maturities. Compared to a standard VAR, this approach has the advantage of incorporating the information embedded in a large crosssection of bond prices. Moreover, the pricing equations provide new ways to assess the model’s ability to capture risk preferences and expectations. Our results suggest that government deficits affect long term interest rates, at least temporarily: (i) a one percentage point increase in the deficit to GDP ratio increases the 10year rate by 35 basis points after 3 years; (ii) this increase is partly due to higher expected spot rates, and partly due to higher risk premia on long term bonds; and (iii) the fiscal policy shocks account for up to 13 % of the variance of forecast errors in bond yields.
Why Gaussian MacroFinance Term Structure Models are (Nearly) Unconstrained FactorVARs.” Discussion paper,
, 2011
"... ABSTRACT This article develops a new family of Gaussian macrodynamic term structure models (MTSMs) in which bond yields follow a lowdimensional factor structure and the historical distribution of bond yields and macroeconomic variables is characterized by a vectorautoregression with order p > 1 ..."
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Cited by 21 (7 self)
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ABSTRACT This article develops a new family of Gaussian macrodynamic term structure models (MTSMs) in which bond yields follow a lowdimensional factor structure and the historical distribution of bond yields and macroeconomic variables is characterized by a vectorautoregression with order p > 1. Most formulations of MTSMs with p > 1 are shown to imply a much higher dimensional factor structure for yields than what is called for by historical data. In contrast, our "asymmetric" arbitragefree MTSM gives modelers the flexibility to match historical lag distributions with p > 1 while maintaining a parsimonious factor representation of yields. Using our canonical family of MTSMs we revisit: (i) the impact of noarbitrage restrictions on the joint distribution of bond yields and macro risks, comparing models with and without the restriction that macro risks are spanned by yieldcurve information; and (ii) the identification of the policy parameters in Taylorstyle monetary policy rules within MTSMs with macro risk factors and lags. ( JEL: G12,E43, C58, E58) KEYWORDS: Macrofinance term structure model, Lags, Taylor Rule Identification Dynamic term structure models in which a subset of the pricing factors are macroeconomic variables (MTSMs) often have bond yields depending on lags of these factors. 1 As typically parameterized, such MTSMs imply that the crosssection
Affine general equilibrium models.
 Management Science
, 2006
"... Abstract Noarbitrage models are extremely flexible modelling tools, but often lack economic motivation. This paper describes an equilibrium consumption based CAPM framework based on EpsteinZin preferences, which produces analytic pricing formulas for stocks and bonds under the assumption that mac ..."
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Cited by 20 (1 self)
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Abstract Noarbitrage models are extremely flexible modelling tools, but often lack economic motivation. This paper describes an equilibrium consumption based CAPM framework based on EpsteinZin preferences, which produces analytic pricing formulas for stocks and bonds under the assumption that macro growth rates follow affine processes. This allows the construction of equilibrium pricing formulas while maintaining the same flexibility of state dynamics as in noarbitrage models. In demonstrating the approach, the paper presents a version of the Bansal & Yaron (2004) model which maintains a positive volatility process, as well as an example in which the volatility process is allowed to jump. The latter produces endogenous asset stock market crashes as stock prices drop to reflect a higher expected rate of return in response to increased risk. A third generalization is a model of nominal stock and bond prices. The nominal yield curve in this model has positive slope if expected inflation growth negatively impacts real growth. This model also produces asset prices that are consistent with observed data, including a substantial equity premium at moderate levels of risk aversion.
Monetary Policy Shifts and the Term Structure,”NBER working paper 13448
, 2008
"... Interest rate risk; timevarying parameter model. The paper has benefited from discussions with Michael Johannes and Monika Piazzesi. We thank seminar participants at UT Austin, the Capital Group, and the Federal Reserve Board. We thank Rudy LooKung for excellent research assistance. Andrew Ang and ..."
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Cited by 20 (1 self)
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Interest rate risk; timevarying parameter model. The paper has benefited from discussions with Michael Johannes and Monika Piazzesi. We thank seminar participants at UT Austin, the Capital Group, and the Federal Reserve Board. We thank Rudy LooKung for excellent research assistance. Andrew Ang and Jean Boivin acknowledge support from the NSF (SES0137145 and SES0518770).
Risk and return on bond, currency and equity markets: A unified approach. Working paper
, 2007
"... George Tauchen, Adrien Verdelhan for their helpful comments and suggestions. The usual disclaimer applies. Risk and Return in Bond, Currency and Equity Markets We develop a general equilibrium longrun risks model that can simultaneously account for key asset price puzzles in bond, currency and equ ..."
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Cited by 19 (5 self)
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George Tauchen, Adrien Verdelhan for their helpful comments and suggestions. The usual disclaimer applies. Risk and Return in Bond, Currency and Equity Markets We develop a general equilibrium longrun risks model that can simultaneously account for key asset price puzzles in bond, currency and equity markets. Specifically, we show that the model can explain the predictability of returns and violations of the expectations hypothesis in bond and foreign exchange markets. It also accounts for the levels and volatilities of bond yields and exchange rates, and the wellknown risk premium and volatility puzzles in equity markets. The model matches the observed consumption and inflation dynamics. Using domestic and foreign consumption and asset markets data we provide robust empirical support for our models predictions. We argue that key economic channels featured in the longrun risks model — longrun growth fluctuations and timevarying uncertainty, along with a preference for early resolution of uncertainty — provide a coherent framework to simultaneously explain a rich array of asset market puzzles. 1
NoArbitrage Taylor Rules
 NBER Working Paper 13448, National Bureau of Economic Research, Inc
, 2007
"... monetary policy, interest rate risk We especially thank Bob Hodrick for providing detailed comments and valuable suggestions. ..."
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Cited by 11 (0 self)
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monetary policy, interest rate risk We especially thank Bob Hodrick for providing detailed comments and valuable suggestions.
Expectations, Bond Yields and Monetary Policy
, 2005
"... Through explicitly incorporating analysts ’ forecasts as observable factors in a dynamic arbitragefree model of the yield curve, this paper proposes a framework for studying the impact of shifts in market sentiment on interest rates of all maturities. An empirical examination reveals that survey exp ..."
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Cited by 10 (0 self)
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Through explicitly incorporating analysts ’ forecasts as observable factors in a dynamic arbitragefree model of the yield curve, this paper proposes a framework for studying the impact of shifts in market sentiment on interest rates of all maturities. An empirical examination reveals that survey expectations about inflation, output growth and the anticipated path of monetary policy actions contain important information for explaining movements in bond yields. Although perceptions about inflation are largely responsible for movements in longterm interest rates, an explicit slope factor is necessary to adequately capture the dynamics of the yield curve. Macroeconomic forecasts play an important role in explaining timevariation in the market prices of risk, with forecasted GDP growth playing a dominant role. The estimated coefficients from a forwardlooking monetary policy rule support the assertion that the central bank preemptively reacts to inflationary expectations while suggesting patience in accommodating real output growth expectations. Models of this type may provide traders and policymakers with a new set of tools for formally assessing the reaction of bond yields to shifts in market expectations due to the arrival of news or central bank statements and announcements.