Term premium dynamics in an emerging market: Risk,liquidity, and behavioral factors |
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| Affiliation: | 1. Bucharest University of Economic Studies, Bucharest, Romania;2. National Scientific Research Institute for Labour and Social Protection, Department of Education, Training and Labour Market, Bucharest, Romania;3. Institute for Economic Forecasting, Romanian Academy, Bucharest, Romania;1. Department of Mathematics/Actuarial Science, Sungkyunkwan University, Seoul, Republic of Korea;2. Department of Economics, Sungkyunkwan University, Seoul, Republic of Korea;3. Korea Fiscal Information Service, Seoul, Republic of Korea;1. School of Statistics and Mathematics, Shandong University of Finance and Economics, Jinan, China;2. School of Urban and Regional Science, Shanghai University of Finance and Economics, Shanghai, China;3. Department of Applied Finance, Macquarie University, Sydney, Australia;4. School of Geography, Earth and Environmental Sciences, University of Birmingham, Birmingham, UK |
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| Abstract: | This paper contributes to the fixed income research by identifying determinants of term premium in an emerging market’s treasury bond yields with particular attention on ambiguity. We use Nelson–Siegel yield curves generated from daily bond price quotes as input to construct a three-factor affine term structure model which decomposes observed yields into risk-neutral and term premium components. We also construct an ambiguity index using intraday FX return data following Brenner and Izhakian (2018). Our analyses suggest that a combination of factors representing market risk, credit risk, liquidity, ambiguity, and investor sentiments can explain majority of the variation in term premia. Explanatory power of credit risk measures are found to increase while those of volatility, ambiguity, and sentiment measures diminish with the maturity horizon. The results imply that ambiguity aversion of bond investors is a major determinant of the shape of the yield curve as it drives the premia for short end of the yield curve lower in line with the expectation of flight-to-safety behavior. |
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| Keywords: | Term premium Behavioral finance Risk Liquidity Ambiguity |
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