Regime Shifts, Risk Premiums in the Term Structure, and the Business Cycle
AbstractWe examine various dynamic term structure models for monthly US Treasury yields from 1964 to 2001. Of particular interest is the predictability of bond excess returns. Recent evidence indicates that using multiple forward rates can sharply predict future excess returns on bonds; the R2 of this predictability regression can be as high as 30%. In addition, the projection coefficients in these predictability regressions exhibit a tent shaped pattern that relates to the maturity of the forward rate. This dimension of the data in conjunction with the transition dynamics of bond yields (i.e., conditional volatility and cross-correlation of bond yields) poses an serious challenge to term structure models. In this paper we present and estimate a regime-shifts term structure model, and our findings show that this model can account for all aspects of the predictability regression and the transition dynamics of yields. Alternative models, such as affine factor models, cannot account for these features of the data. We find that the regimes in the model are related to the NBER business-cycle indicator.
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Bibliographic InfoArticle provided by American Statistical Association in its journal Journal of Business and Economic Statistics.
Volume (Year): 22 (2004)
Issue (Month): (October)
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Other versions of this item:
- Ravi Bansal & George Tauchen & Hao Zhou, 2003. "Regime-shifts, risk premiums in the term structure, and the business cycle," Finance and Economics Discussion Series 2003-21, Board of Governors of the Federal Reserve System (U.S.).
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