Macroeconomic Sources of Risk in the Term Structure

We develop a new way of modeling time variation in term premia, based on the stochastic discount factor model of asset pricing. The joint distribution of excess U.S. bond returns of different maturity and the observable fundamental macroeconomic factors is modeled using multivariate GARCH with condi...

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Bibliographic Details
Published in:Journal of money, credit and banking credit and banking, 2007-02, Vol.39 (1), p.205-236
Main Authors: BALFOUSSIA, HIONA, WICKENS, MIKE
Format: Article
Language:English
Subjects:
Arbitrage
Asset valuation
Bank credit
Bond markets
Capital market
Coefficients
Company pricing policy
Credit
Credit market
Credit markets
Data analysis
Financial bonds
Financial economics
Financial instruments
Financial risks
Forecasts and trends
GARCH
GARCH models
Interest rates
Macroeconomic modeling
Macroeconomics
Market trend/market analysis
Price formation
Prices and rates
Rates of return
Rational expectations
Risk
Risk assessment
Risk premiums
Securities
Securities prices
stochastic discount factor model
Stochastic models
Studies
term premia
Term structure
Yield curves
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Summary:We develop a new way of modeling time variation in term premia, based on the stochastic discount factor model of asset pricing. The joint distribution of excess U.S. bond returns of different maturity and the observable fundamental macroeconomic factors is modeled using multivariate GARCH with conditional covariances in the mean to capture the term premia. By testing the assumption of no arbitrage we derive a specification test of our model. We estimate the contribution made to the term premia at different maturities through real and nominal sources of risk. From the estimated term premia we recover the term structure of interest rates and examine how it varies through time. Finally, we examine whether the reported failures of the rational expectations hypothesis can be attributed to an omitted time-varying term premium.
ISSN:0022-2879
1538-4616
DOI:10.1111/j.0022-2879.2007.00009.x