No-arbitrage Near-Cointegrated VAR(p) term structure models,term premia and GDP growth

The recent macro-finance literature does not agree either about the empirical properties of the expectation part and of the term premium on long-term bonds or about the importance or even the direction of the relationship between the term premium and future economic activity. This paper proposes a two-step approach to handle both problems. First, in a VAR setting, we extract a reliable measure of the term premium by means of averaging estimator techniques aiming at optimally solving prediction problems when highly persistent processes are present and, thus, providing a so called Near-Cointegrated VAR(p) approach. Second, we analyze the dynamic response of GDP to shocks to the term premium by using the New Information Response Function concept. As far as the first problem is concerned, we find that the NCVAR-based term premium measure is rather stable and counter-cyclical, as suggested by interest rates survey-based estimation of yield curve models and by its risk compensation role. Regarding the second problem, we find that an increase in the long-term spread caused by the term premium induces two effects on future economic activity: the impact is negative for short horizons (less than 1 year), whereas it is positive for longer ones.     

Time-varying risk premium yield spread effect in term structure and global financial crisis: Evidence from Europe

The global financial crisis had a significant effect on the interest rates and the term structure of interest rates around the globe. In this paper we apply the GARCH-in-mean (GARCH-M) to study the effect of the global financial crisis on the term structure volatility, persistence of volatility, risk premium, and effects of the yield spread in five European markets; Portugal, Ireland, Italy, Greece and Spain (PIIGS). To the best of our knowledge this is the first such study in the field, and thus represents the main contribution of the paper to the literature. We investigate both the longer end and the shorter end of the term structure. We study two versions of the longer end based on the 10-year bond (long-term rate) and the two short-term rates, (three- and six-month rates). The shorter end of the term structure is based on the two short-term rates. Results indicate a substantial change in the term structure volatility, persistence of volatility, risk premium, and the effects of the yield spread due to the financial crisis. These results are found for both the longer end and the shorter end versions of the term structure.     

Short-term determinants of the idiosyncratic sovereign risk premium: A regime-dependent analysis for European credit default swaps

This study investigates the dynamics of the sovereign CDS term premium, i.e. difference between 10Y and 5Y CDS spreads. It can be regarded a forward-looking measure of idiosyncratic sovereign default risk as perceived by financial markets. For some European countries this premium featured distinct nonstationary and heteroskedastic pattern during the last years. Using a Markov-switching unobserved component model, we decompose the daily CDS term premium of five European countries into two unobserved components of statistically different nature and link them in a vector autoregression to various daily observed financial market variables. We find that such decomposition is vital for understanding the short-term dynamics of this premium. The strongest impacts can be attributed to CDS market liquidity, local stock returns, and overall risk aversion. By contrast, the impact of shocks from the sovereign bond market is rather muted. Therefore, the CDS market microstructure effect and investor sentiment play the main roles in sovereign risk evaluation in real time. Moreover, we also find that the CDS term premium response to shocks is regime-dependent and can be ten times stronger during periods of high volatility.     

Is the Term Premium a Risk Premium?

This paper explores whether excess holding period returns on long vis-a-vis short-term securities behave in a manner that is consistent with (1) market efficiency, (2) the time-varying-term-premium variant of the expectations hypothesis, and (3) theories of the term premium that view it as a reward for risk bearing. Both traditional and modern theories of the term premium imply that it should evolve fairly slowly over time as attitudes toward risk and/or perceived covariances with wealth or consumption change. This implies that this period's term premium should have some predictive ability for next period's. However, we find that this quarter's ex-post term premium has zero predictive ability. For monthly rates and returns, the evidence is less clear cut, but again the implied term premia do not behave in a manner consistent with existing theories.     

交易所国债期限风险溢价的实证研究

本文考察了上海证券交易所国债期限风险溢价的时间变化特征及决定因素。实证结果显示，债券剩余期限越长，平均风险溢价越高；通过对不同期限债券组合的风险溢价序列建立回归模型，发现长短期利差及风险溢价的前期值对中长期债券期限风险溢价的时变性具有明显的解释能力。     

The role of no-arbitrage on forecasting: Lessons from a parametric term structure model

Parametric term structure models have been successfully applied to numerous problems in fixed income markets, including pricing, hedging, managing risk, as well as to the study of monetary policy implications. In turn, dynamic term structure models, equipped with stronger economic structure, have been mainly adopted to price derivatives and explain empirical stylized facts. In this paper, we combine flavors of those two classes of models to test whether no-arbitrage affects forecasting. We construct cross-sectional (allowing arbitrages) and arbitrage-free versions of a parametric polynomial model to analyze how well they predict out-of-sample interest rates. Based on US Treasury yield data, we find that no-arbitrage restrictions significantly improve forecasts. Arbitrage-free versions achieve overall smaller biases and root mean square errors for most maturities and forecasting horizons. Furthermore, a decomposition of forecasts into forward-rates and holding return premia indicates that the superior performance of no-arbitrage versions is due to a better identification of bond risk premium.     

The information content of the term structure of risk-neutral skewness

We seek to reconcile the debate about the price effect of risk-neutral skewness (RNS) on stocks. We document positive predictability from short-term skewness, consistent with informed-trading demand, and negative predictability from long-term skewness, consistent with skewness preference. A term spread on RNS captures different information from long- and short-term contracts, resulting in stronger predictability. The quintile portfolio with the lowest spread outperforms that with highest spread by 14.64% annually. The term structure of RNS predicts earnings surprises and price crashes. We extract the slope factor from RNS term structure, estimate its risk premium, and explore its relation with several macroeconomic variables.     

Time-varying term premium in T-bill futures rate and the expectations hypothesis

This paper examines time-varying term premium in the T-bill futures rate to determine its significance for the expectations hypothesis (EH). Similar to previous studies on the T-bill forward rates, our data reject the joint hypothesis of the EH and the rational expectations hypothesis (RE). Under the assumption of zero rational expectational error, we find a substantial variation of term premium in the futures rate over time. Furthermore, the lower bound of the expected term premium variance is significantly positive when the rational expectational error is allowed to be nonzero. These findings are inconsistent with the EH. In addition, a relatively high ratio of the lower bound of the expected term premium variance to the prediction error variance implies that the poor predictive power of the futures rate should not be attributed mainly to the market's rational expectational errors.     

国债回购市场利率价差预测能力的再检验

本文在给出利率预期假说理论模型和相关推论的基础上，在误差修正模型框架下采用因子分解技术，将两个利率序列分解成长期记忆成分和短暂成分，并通过将短暂成分对利率价差进行回归，以此来检验回购市场长短期利率价差的预测能力。结果表明，利率价差对去除长期记忆成分后未来利率变化的短暂成分的预测能力显著增强，而对于短期利率序列的纯长期记忆成分的预测能力则很差。     

Mean-variance cointegration and the expectations hypothesis

The present paper sheds further light on a well-known (alleged) violation of the expectations hypothesis of the term structure (EHT): the frequent finding of unit roots in interest rate spreads. We show that the EHT implies (i) that the nonstationarity stems from the holding premium, which is hence (ii) cointegrated with the spread. In a stochastic discount factor framework, we model the premium as being driven by the integrated variance of excess returns. Introducing the concept of mean-variance cointegration, we actually find cointegration relations between the conditional first and second moment of US bond data.     

Is the ex‐ante equity risk premium always positive? Evidence from a new conditional expectations model

We model the conditional risk premium by combining principal component analysis and a statistical learning technique, known as boosted regression trees. The method is validated through various out‐of‐sample tests. We apply the estimates to test the positivity restriction on the risk premium and find evidence that the risk premium is negative in periods of low corporate and government bond returns, high inflation and downward‐sloping term structure. These periods are linked with changes in business cycles; the states when theories predict the existence of negative risk premium. Based on the evidence, we reject the conditional capital asset pricing model and raise a question over the practice of imposing the positive risk premium constraint in predictive models.     

Forecasting GDP growth with financial market data in Finland: Revisiting stylized facts in a small open economy during the financial crisis

This paper examines the ability of financial variables to predict future economic growth above and beyond past economic activity in a small open economy in the euro area. We aim to clarify potential differences in forecasting economic activity during different economic circumstances.Our results from Finland suggest that the proper choice of forecasting variables is related to general economic conditions. During steady economic growth, the preferred choice for a financial indicator is the short-term interest rate combined with past values of output growth. However, during economic turbulence, the traditional term spread and stock returns are more important in forecasting GDP growth. The time-varying predictive content of the financial variables may be utilized by applying regime-switching nonlinear forecasting models. We propose a novel application using the negative term spread and observed recession as signals to switch between regimes. This procedure yields a significant improvement in forecasting performance at the one-year forecast horizon.     

A century of equity premium predictability and the consumption–wealth ratio: An international perspective

This paper re-examines the predictive ability of the consumption–wealth ratio (cay) on the equity premium using hand-collected annual data spanning one century for four major economies. In addition to statistical tests of out-of-sample forecast accuracy, we measure the economic value of the predictive information in cay in a stylized asset allocation strategy. We find that cay does not contain predictive power prior to World War II, when a structural break occurs for all countries. In the postwar period, while statistical tests provide mixed evidence, economic criteria uncover substantial predictive power in cay, further enhanced when allowing for economically meaningful restrictions.     

The effect of Fed monetary policy regimes on the US interest rate swap spreads

This paper analyzes the asymmetric impacts of various economic shocks on swap spreads under distinct Fed monetary policy regimes. The results indicate that (a) during periods of aggressive interest rate reductions, slope of the Treasury term structure accounts for a sizeable share of the swap spread variance although default shock is also a major player. (b) On the other hand, liquidity premium is the only contributor to the 2-year swap spread variance in monetary tightening cycles. (c) The impact of default risk varies across both monetary cycles and swap maturities. (d) The effect of interest rate volatility is generally more evident in loosening monetary regimes.     

Modeling volatility and changes in the swap spread

We investigate the determinants of changes in U.S. interest rate swap spreads using a model that explicitly allows for volatility interactions between swaps of different terms to maturity. Changes in the swap spread are found to be positively related to interest rate volatility, to changes in the default risk premium in the corporate bond market, and to changes in the liquidity premium for government securities. Swap spread changes are negatively related to changes in the level of interest rates and changes in the slope of the term structure. We also find that there is a strong and significant volatility interaction among spreads for swaps of different maturities and that the process for the conditional variance of the spread is highly persistent across all maturities.     

TIME VARYING RISK PREMIUM AND THE PREDICTIVE POWER OF THE AUSTRALIAN TERM STRUCTURE OF INTEREST RATES

Using weekly data on bank accepted bills over the 1976 to 1993 period, this paper provides direct evidence of the presence of a term premium in the Australian term structure. The term premium is shown to vary over time and have an adverse effect on the predictive power of the term structure. The variance of the expected term premium is quantified in terms of its lower bound relative to the upper bound of the variance of the rational expectations error. This ratio is observed to vary over sample sub periods and rise to a high of one in some periods which include the period immediately prior to the market crash.     

The international transmission of risk: Causal relations among developed and emerging countries’ term premia

We study the effect of shocks to the United States government bonds term premium on Latin American government bonds term premia. For doing so, we compute dynamic multipliers. Our main findings indicate that Latin American countries’ term premia respond permanently to changes in United States term premium. However, impulse-response functions vary depending on the country and particular time-length for which premia are computed. Responses are larger for Brazil and Colombia. Mexico exhibits the lowest responses for the four economies in our study. We discuss some political economy implications of our main findings.     

Uncovering the US term premium: An alternative route

The estimates of the US term premium crucially depend upon the ex-ante decision on whether the short-term rate is either an I(0) or an I(1) process. In this paper we estimate a fractionally integrated (I(d)) model which simultaneously determines both the order of integration of the short-term rate and the associated term premium. We show that the term premium experienced a sharp increase from essentially zero in mid-2007 to almost 3% in 2009. We also show that unemployment and term premium dynamics exhibit a very significant positive co-movement.     

Determinants of Sovereign Eurobonds Yield Spread

We examine the determinants of sovereign Eurobond spread at issuance covering 1991–2000. The results of the regression models showed that yield spread increases with maturity, issue size and gross fees and decreases with credit rating and the number of managers. Higher‐grade issuers also pay a relatively higher spread to borrow long‐term funds and for smaller issues. The findings are consistent with the notion of a term structure 'liquidity premium.' Low‐grade issuers pay a higher spread than better‐rated countries. However, low‐grade countries pay high spread for larger funds. Credit rating is found to provide additional information in explaining the spread on sovereign Eurobonds beyond that provided by macroeconomic variables.     

Determinants of market-assessed sovereign risk: Economic fundamentals or market risk appetite?

This paper examines the determinants of the market-assessed sovereign risk premium, measured by the Brady bond stripped yield spread. Our study shows that, while standard economic fundamentals of a sovereign significantly affect the bond yield spread, the market's attitude towards risk is another important determinant. We construct a measure of the market's attitude towards risk called the risk appetite index (RAI), and find that for comparable changes in all the economic variables the RAI has a relatively large impact on the Brady bond yield spread. Our results explain why there is contagion in the Brady bond market and why often there is a divergence between the market's perception of the country risk premium and published ratings on sovereign creditworthiness.