A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets

Bansal, Ravi; Shaliastovich, Ivan

doi:10.1093/rfs/hhs108

Cited by 355 publications

(177 citation statements)

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“…Backus, Gregory, and Zin (1989) show that a standard consumption-based model with power utility fails to account for sign, magnitude, and volatility of the term spread. The bond pricing mechanisms of this paper are most closely related to Piazzesi and Schneider (2007) and Bansal and Shaliastovich (2013). The bond pricing mechanisms of this paper are most closely related to Piazzesi and Schneider (2007) and Bansal and Shaliastovich (2013).…”

Section: Introductionmentioning

confidence: 89%

“…In sum, the model endogenizes the consumption growth and inflation dynamics specified in Piazzesi and Schneider (2007) and Bansal and Shaliastovich (2013). In response to this shock, firms increase investment, which boosts expected productivity growth persistently.…”

Section: Equilibrium Growth and Inflationmentioning

confidence: 99%

“…Consumptionbased models with richer preference specifications and model dynamics, such as Wachter (2006), Piazzesi and Schneider (2007), Gallmeyer, Hollifield, Palomino, and Zin (2007), and Bansal and Shaliastovich (2013), find more success. The present model endogenizes the inflation and consumption growth dynamics from Piazzesi and Schneider (2007) and Bansal and Shaliastovich (2013) and connects them to firms' production decisions. The present model endogenizes the inflation and consumption growth dynamics from Piazzesi and Schneider (2007) and Bansal and Shaliastovich (2013) and connects them to firms' production decisions.…”

Section: Introductionmentioning

confidence: 99%

“…The units of the y-axis are annualized percentage deviations from the steady state.11 For example, seePiazzesi and Schneider (2007) andBansal and Shaliastovich (2013). This figure plots impulse response functions of productivity (a), real marginal costs (mc), expected inflation ðE½πÞ, the log research and development rate ðs À nÞ, and expected consumption growth ðE½ΔcÞ to a positive productivity shock (ϵ t ).…”

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confidence: 99%

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Macroeconomic linkages between monetary policy and the term structure of interest rates

Kung

2015

Journal of Financial Economics

126

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JEL classification: E43 E44 G12 G18 Keywords:Term structure of interest rates Asset pricing Recursive preferences Monetary policy Endogenous growth Inflation Productivity a b s t r a c t This paper studies the equilibrium term structure of nominal and real interest rates and the time-varying bond risk premia implied by a stochastic endogenous growth model with imperfect price adjustment and monetary policy shocks. The production and pricesetting decisions of firms drive low-frequency movements in growth and inflation rates that are negatively related. With recursive preferences, these growth and inflation dynamics are crucial for rationalizing key stylized facts in bond markets. When calibrated to macroeconomic data, the model quantitatively explains the means and volatilities of nominal bond yields and the failure of the expectations hypothesis.Please cite this article as: Kung, H., Macroeconomic linkages between monetary policy and the term structure of interest rates. Journal of Financial Economics (2014), http://dx.

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Section: Introductionmentioning

confidence: 89%

Section: Equilibrium Growth and Inflationmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

mentioning

confidence: 99%

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Macroeconomic linkages between monetary policy and the term structure of interest rates

Kung

2015

Journal of Financial Economics

126

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“…The equity premium puzzle reflects the difficulty to price equities and the risk‐free rate. Solutions to the puzzle (Campbell and Cochrane, 1999; Bansal and Yaron, 2004) have been extended to price the term structure of interest rates (Wachter, 2006; Bansal and Shaliastovich, 2009; respectively). However, those models are calibrated to fit stylized facts about the term structure.…”

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confidence: 99%

Risk aversion, intertemporal substitution, and the term structure of interest rates

García

Luger

2011

J of Applied Econometrics

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SUMMARY We build and estimate an equilibrium model of the term structure of interest rates based on a recursive utility specification. We contrast it with an arbitrage‐free model, where prices of risk are estimated freely without preference constraints. In both models, nominal bond yields are affine functions of macroeconomic state variables. The equilibrium model accounts for the tent‐shaped pattern and magnitude of coefficients from predictive regressions of excess bond returns on forward rates and the hump‐shaped pattern in the term structure of volatilities, while the reduced‐form no‐arbitrage model does not account for these important features of the yield curve. Copyright © 2011 John Wiley & Sons, Ltd.

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Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity

Pflueger

Viceira²

2016

Handbook of Fixed‐Income Securities

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There is wide consensus among financial economists that returns on nominal U.S. Treasury bonds in excess of Treasury bills are predictable at different investment horizons. Predictor variables include forward rates (Fama and Bliss, 1987), the slope of the yield curve (Campbell and Shiller, 1991), and a linear combination of forward rates (Cochrane and Piazzesi, 2005). There is however an ongoing discussion about what drives this predictability. We contribute to this discussion by conducting a joint empirical analysis of the sources of excess bond return predictability in nominal and inflation-indexed bonds in the U.S. and the U.K. Specifically, we provide evidence that both time-varying inflation risk premia and time-varying real interest rate risk premia are quantitatively important in explaining time variation in the expected excess return on nominal bonds. The question whether expected excess returns of inflation-indexed bonds are time-varying is important on its own. It remains relatively unexplored, partly due to the short history of U.S. inflation-indexed bonds (Campbell, Shiller, and Viceira, 2009). We contribute to the emerging research on inflation-indexed bonds by examining and distinguishing among three potential sources of excess return predictability in inflation-indexed bonds: time-varying real interest rate risk, timevarying liquidity risk, and market segmentation. Our work differs from recent work on inflationindexed bond return predictability by Campbell, Sunderam, and Viceira (2013) and Pflueger and Viceira (2011) in that it finds and corrects for an economically significant liquidity risk premium, which otherwise would likely distort estimates of real rate and inflation risk premia. Novel and unique to our work is the finding that a liquidity component in breakeven inflation, or the spread between nominal and inflation-indexed bond yields of similar maturity, predicts the return differential between nominal and inflation-indexed bonds due to liquidity. The estimated U.S. return differential due to liquidity exhibits a significantly positive stock market CAPM beta, suggesting that U.S. TIPS investors bear systematic liquidity risk and should be compensated in terms of a positive return premium. While the return differential due to liquidity is not directly 1 tradable, this result is relevant to investors who may differ in terms of their exposure to liquidity crises. Research in financial economics has proposed several theories to explain predictability in nominal excess bond returns. One hypothesis is that excess return predictability results from time variation in the aggregate price of risk. Building on the habit preferences model of Campbell and Cochrane (1999), Wachter (2006) shows that a model with time-varying real interest rates can generate nominal bond excess return predictability. Second, excess return predictability could result from time variation in expected aggregate consumption growth or its volatility. The long-run consumption risk model of Bansal and Yaron (2004) and Bansal, Kik...

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A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets

Cited by 355 publications

References 53 publications

Macroeconomic linkages between monetary policy and the term structure of interest rates

Macroeconomic linkages between monetary policy and the term structure of interest rates

Risk aversion, intertemporal substitution, and the term structure of interest rates

Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity

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