New tips from TIPS: Identifying inflation expectations and the risk premia of break-even inflation

This paper decomposes the break-even inflation rates derived from inflation-indexed bonds into inflation risk premia, liquidity risk premia, and inflation expectations. I estimate a common factor model with autoregressive conditionally heteroscedastic (ARCH) errors that extracts co-movements from twenty-two monthly and quarterly indicators to identify these three components. The results indicate that the sharp declines in the 10-year and 5-year break-even inflation rates in 2009 reflect a substantial increase in liquidity risk rather than a decrease in inflation expectations. Break-even inflation rates underestimate inflation expectations over nearly the entire sample due to the liquidity risk premia carried by the inflation indexed bond yields. Also, the model-implied inflation expectations show better forecast performance for the average annual inflation rates than raw break-even inflation rates, the Survey of Professional Forecasters, and the Surveys of Consumers inflation forecasts.     

INFORMATION IN THE YIELD CURVE: A MACRO‐FINANCE APPROACH

We use a macro‐finance model, incorporating macroeconomic and financial factors, to study the term premium in the US bond market. Estimating the model using Bayesian techniques, we find that a single factor explains most of the variation in bond risk premiums. Furthermore, the model‐implied risk premiums account for up to 40% of the variability of one‐ and two‐year excess returns. Using the model to decompose yield spreads into an expectations and a term premium component, we find that, although this decomposition does not seem important to forecast economic activity, it is crucial to forecast inflation for most forecasting horizons. Copyright © 2012 John Wiley & Sons, Ltd.     

流动性与交易所市场回购利率

在发达的金融市场上,回购利率的期限结构服从纯预期假设,无论从经济意义上还是从统计意义上来说风险溢酬都不显著。但是中国金融市场作为新兴市场表现出一些不同点。本文利用2000年1月到2006年2月上海证券交易所的回购数据,发现长期回购利率有明显的风险溢酬,预期理论并不成立。进一步分析得到流动性是影响风险溢酬的一个关键因素,流动性的预期和流动性的随机冲击都对观察到的风险溢酬有影响,并且流动性的预期是主要的影响因素。     

A Reconciliation of Some Paradoxical Empirical Results on the Expectations Model of the Term Structure

In this paper we attempt to reconcile contradictory empirical results for the expectations model of the term structure which are found when it is tested by a variety of methods based on single-equation and VAR models. Using monthly data for one-month and three-month interest rates, we show that the expectations hypothesis is rejected for the US and UK term structures on the basis of some popular tests. However, tests based on VAR models or on IV regressions of yield spreads on future short rate changes provide no evidence against the expectations model with a random component in the term premium.     

The Expectations Hypothesis of the Term Structure and Time-Varying Risk Premia: a Panel Data Approach

One implication of the expectations hypothesis is that the yield spread should forecast subsequent changes in the long yield. However, regression tests based on this specification strongly reject the expectations hypothesis. One explanation for this rejection is that these tests fail to allow for a time varying risk premium that is correlated with this yield spread, leading to a bias in the estimated regression coefficients. This paper uses panel data in order to testm the expectations hypothesis under the assumption that risk premia are time-varying but driven by a single factor. It is found that while the expectations hypothesis is still rejected, the bias in the estimated coefficient is verysubstantially reduced.     

Explaining US–UK Interest Rate Differentials: A Reassessment of the Uncovered Interest Rate Parity in a Bayesian Framework*

In this paper, we test the uncovered interest rate parity (UIRP), allowing for transitory deviations from it. These deviations may arise from variations in risk premia, errors in expectations and linearization errors, and are modelled as a zero‐mean noise around the restrictions implied by the UIRP on a vector autoregression (VAR) in the interest rate differential and the spot exchange rate. Importantly, this approach includes the traditional one as a special case, which is derived by simply setting the noise to zero. When the noise is set to zero the UIRP is rejected, but if we allow for some degree of noise the UIRP is strongly supported by the data. Thus the UIRP relation does not hold exactly, but on average, with a stationary risk premium as opposed to a constant one. This result implies that analysing the effects of policy experiments under the null of the UIRP may be both safe and useful.     

THE TERM STRUCTURE OF INTEREST RATES: EVIDENCE AND THEORY

Abstract. The term structure of interest rates is an old topic. Over the years, both the hypotheses debated and the research techniques used have changed considerably. Two fairly recent developments which distinguish current research are the widespread adoption of rational expectations and the integration of the term structure with the general theory of asset pricing. This survey reviews previous work from this perspective. The main objective is to catalogue available evidence about term premia and to interpret this evidence in light of alternative models of term premia determination.     

What drives the liquidity premium in the Chinese stock market?

This paper examines the dynamics of the liquidity premium in the Chinese stock market by adopting a multivariate decomposition approach to measure the individual contributions of various driving forces of the premium (such as firm size, idiosyncratic volatility, and market liquidity betas). By employing a wide range of liquidity measures, we show that liquidity premium is generally significant in the Chinese stock market. Furthermore, this premium is increasing in recent years starting from 2011; this observation is different from the United States market, in which the premium has declined over the years. Moreover, the multivariate decomposition approach highlights several asset pricing factors as the main driving forces of the premium. Based on the Amihud liquidity measure, the decomposition approach indicates that the size factor contributes 45–65% to the liquidity premium. However, the measure based on turnover suggests that idiosyncratic volatility accounts for at least 60% of the liquidity premium. In contrast, the global market liquidity beta does not significantly contribute to the premium. However, there is some evidence that the local market liquidity beta has become more significant in its impact on the premium during the period from 2011 to 2015. Our results imply that the findings on the liquidity premium in the Chinese stock market could be sensitive to the liquidity measure used and period of analysis.     

The maturity structure of term premia with time-varying expected returns

This paper analyzes the maturity structure of term premia using McCulloch’s US Treasury yield curve data from 1953–91, allowing expected returns to vary across time. One, 3, 6, and 12 month holding period returns on maturities up to 5 years are projected on 3 ex ante variables to compute time-varying expected returns, and simulations are employed to generate distributions of conditionally expected return premia. The likelihood of expected returns monotonically increasing in maturity (as implied by the liquidity preference hypothesis) is relatively high when the yield curve is steep and interest rates are high, and with longer holding periods, but low in other cases. The hypothesis that intermediate maturity bonds have the highest expected returns (a “hump-shaped” maturity-return pattern) around the onset of recessions does not receive much support.     

An examination of the forward prediction error of U.S. dollar exchange rates and how they are related to bid-ask spreads,purchasing power parity disequilibria,and forward premium asymmetry

Using a panel data approach, we find statistically significant evidence that bid-ask spreads and deviations from purchasing power parity (PPP) are related to the forward prediction error of ten major U.S. dollar exchange rates over the post Plaza Accord period. Previous literature suggests that bid-ask spreads proxy for liquidity risk and deviations from PPP are a source of time-varying risk premiums. Additionally, the paper provides evidence that the forward discount bias is asymmetric with respect to the sign of the forward premium as well as to an undervalued and overvalued U.S. dollar.     

Debt stabilization games in the presence of risk premia

As a result of the recent financial crisis and the ensuing economic recession, fiscal deficits have soared in many OECD countries. As a consequence, government debt has been on the rise again after a period of stable or declining government debt. In this paper we analyze debt stabilization in a country that features endogenous risk premia, imposed by financial markets that evaluate the probability of debt default by governments. Endogenous risk premia arise by assuming, e.g., simple linear relations between risk premia and the level of debt. As a result the real interest rate on government debt can be written as a constant (measuring the risk-free real interest rate corrected for real output growth) plus an endogenous risk premium that depends on the debt level. We bring such an endogenous risk premium into Tabellini (1986) model and analyze the impact of it. This gives rise to a non-linear differential game. We solve this game for both a cooperative setting and a non-cooperative setting. The non-cooperative game is solved under an open-loop information structure. We present a bifurcation analysis w.r.t. the risk premium parameter.     

The role of beliefs in inference for rational expectations models

This paper discusses inference for rational expectations models estimated via minimum distance methods by characterizing the probability beliefs regarding the data generating process (DGP) that are compatible with given moment conditions. The null hypothesis is taken to be rational expectations and the alternative hypothesis to be distorted beliefs. This distorted beliefs alternative is analyzed from the perspective of a hypothetical semiparametric Bayesian who believes the model and uses it to learn about the DGP. This interpretation provides a different perspective on estimates, test statistics, and confidence regions in large samples, particularly regarding the economic significance of rejections in rational expectations models. A suggestive application to the equity premium puzzle is examined.     

Recovering default risk from CDS spreads with a nonlinear filter

We propose a nonlinear filter to estimate the time-varying default risk from the term structure of credit default swap (CDS) spreads. Based on the numerical solution of the Fokker–Planck equation (FPE) using a meshfree interpolation method, the filter performs a joint estimation of the risk-neutral default intensity and CIR model parameters. As the FPE can account for nonlinear functions and non-Gaussian errors, the proposed framework provides outstanding flexibility and accuracy. We test the nonlinear filter on simulated spreads and apply it to daily CDS data of the Dow Jones Industrial Average component companies from 2005 to 2010 with supportive results.     

流动性溢价理论研究述评

资产流动性是否影响资产的价格一直是资本市场理论研究的热点问题,也是投资者决策的重要理论依据之一。本文系统回顾了国内外有关流动性溢价理论的研究现状,分析了我国股市流动性溢价的影响因素,并指出了我国在流动性溢价理论研究方面所存在的问题以及未来的研究方向。     

TIPS and the VIX: Spillovers from Financial Panic to Breakeven Inflation in an Automated,Nonlinear Modeling Framework

This paper examines the determinants of the breakeven inflation rate (BEI) on U.S. Treasury Inflation Protected Securities. After controlling for several measures of liquidity, inflation expectations and inflation uncertainty; financial fear itself (proxied with the Volatility Index or VIX) remains a primary influence on BEI. To delve into the mechanism underlying this association, the VIX is decomposed, using intraday data, into conditional variance and the variance premium capturing risk aversion. Aside from the 2008 crisis, most of the effect emanated from the variance premium. Following the crisis, indicators of bank insolvency risk gain prominence as well. Lastly, an automated nonlinear model finds convex effects of variance, and diminishing returns to insolvency risk and liquidity.     

Expectations Formation and Risk in Three Financial Markets: Surveying What the Surveys Say

This paper attempts to provide a logical overview of the literature which exploits survey data to examine issues of expectations formation and risk aversion in financial markets. Our survey suggests that: short term expectations are excessively volatile and exhibit bandwagon effects, while longer term expectations appear to be regressive and therefore stabilising; in bond and foreign exchange markets the standard result of forward rate biasedness is due in part to time-varying premia; recent research using disaggregate foreign exchange survey data demonstrates the importance of heterogeneous expectations.     

Japan’s impactful augmentation of quantitative easing sovereign-bond purchases

This article examines how and to what extent large-scale government bond purchases in the Bank of Japan’s monetary policy affected two components of long-term interest rates over the period 2009–2015. The article divides market yields on popular 5 and 10-year government bonds into future policy-rate expectations with uncertainty and a specific type of term premia required by investors for the bonds’ demand/supply imbalances, by using overnight index swap rates as a proxy for the former. The Bank of Japan augmented the purchases substantially by starting Quantitative and Qualitative Monetary Easing (QQME) in 2013. The QQME became impactful in the sense that it encouraged investors to improve the first component whilst reducing the second component. These appeared mainly as persisting announcement-effects – upward level shifts of the expectations and downward ones of the term premia. The reduction of term premia was much greater for the 10-year maturity than for 5-year one and strengthened after an additional expansion of the QQME in 2014. The QQME is estimated to have enhanced 5-year sovereign bond yields by 11.9 basis points (bps) a month on average whilst reducing 10-year ones by 8.3 bps. The impact on the 5-year yields turned to be negative after the QQME expansion.     

Firm-specific Human Capital Accumulation: Evidence from Brazil*

We introduce firm-specific returns to experience and tenure into a standard two-way fixed effects model, show that they are separately identified under the standard exogenous mobility assumption and with sufficient between firm mobility, and provide a new evidence on heterogeneity of returns to experience and tenure across firms using the administrative data from Brazil over the years 1999–2014. We document that (1) returns to tenure are not strongly related to firm wage premia, (2) returns to experience are strongly negatively correlated with firm wage premia, (3) the relationship between firm wage premium and return to experience is stronger for ‘blue collar’ firms.     

The relationship between forecast dispersion and forecast uncertainty: Evidence from a survey data—arch model

This paper examines empirically the relationship between measures of forecast dispersion and forecast uncertainty from data on inflation expectations from the Livingston survey series and the Survey Research Center (SRC) survey series. Because the survey series do not provide probabilistic forecasts of inflation, we derive measures of inflation uncertainty by modelling the conditional variance of the inflation forecast errors from the survey series as an autoregressive conditional heteroscedastic (ARCH) process. The analysis is complicated by the fact that the overlap of forecast horizons for the survey series does not preclude the model's disturbance terms from displaying autocorrelation, and also places a restriction on the specification for the ARCH measures of inflation uncertainty. We estimate the model using Hansen's (1982) generalized method of moments (GMM) procedure to account for the presence of serial correlation and conditional heteroscedasticity in the disturbance terms. The results generally support the hypothesis that the measures of forecast dispersion across survey respondents are positively and statistically significantly associated with the measures of inflation uncertainty. However, the appropriateness of using forecast dispersion measures as proxies for inflation uncertainty is sensitive to the choice of the survey series.