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Bond risk premia and realized jump risk

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  • Wright, Jonathan H.
  • Zhou, Hao
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Abstract

We find that augmenting a regression of excess bond returns on the term structure of forward rates with an estimate of the mean realized jump size almost doubles the R2 of the forecasting regression. The return predictability from augmenting with the jump mean easily dominates that offered by augmenting with options-implied volatility and realized volatility from high-frequency data. In out-of-sample forecasting exercises, inclusion of the jump mean can reduce the root mean square prediction error by up to 40%. The incremental return predictability captured by the realized jump mean largely accounts for the countercyclical movements in bond risk premia. This result is consistent with the setting of an incomplete market in which the conditional distribution of excess bond returns is affected by a jump risk factor that does not lie in the span of the term structure of yields.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 33 (2009)
Issue (Month): 12 (December)
Pages: 2333-2345

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Handle: RePEc:eee:jbfina:v:33:y:2009:i:12:p:2333-2345

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Web page: http://www.elsevier.com/locate/jbf

Related research

Keywords: Bond return predictability Expectations hypothesis Countercyclical risk premia Realized jump risk Unspanned factors;

References

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Citations

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Cited by:
  1. Joyce, Michael & Lildholdt, Peter & Sorensen, Steffen, 2009. "Extracting inflation expectations and inflation risk premia from the term structure: a joint model of the UK nominal and real yield curves," Bank of England working papers 360, Bank of England.
  2. Fleming, Jeff & Kirby, Chris, 2011. "Long memory in volatility and trading volume," Journal of Banking & Finance, Elsevier, vol. 35(7), pages 1714-1726, July.
  3. Andrade, Sandro C. & Barrett, W. Brian, 2011. "Can broker-dealer client surveys provide signals for debt investing?," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1170-1178, May.
  4. Todd E. Clark & Michael W. McCracken, 2011. "Tests of equal forecast accuracy for overlapping models," Working Papers 2011-024, Federal Reserve Bank of St. Louis.
  5. Ferstl, Robert & Weissensteiner, Alex, 2011. "Asset-liability management under time-varying investment opportunities," Journal of Banking & Finance, Elsevier, vol. 35(1), pages 182-192, January.
  6. Benoît Sévi & César Baena, 2012. "A reassessment of the risk-return tradeoff at the daily horizon," Economics Bulletin, AccessEcon, vol. 32(1), pages 190-203.
  7. Sévi, Benoît, 2013. "An empirical analysis of the downside risk-return trade-off at daily frequency," Economic Modelling, Elsevier, vol. 31(C), pages 189-197.
  8. Fricke, Christoph, 2012. "Expected and unexpected bond excess returns: Macroeconomic and market microstructure effects," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Leibniz Universität Hannover dp-493, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  9. Duan, Jin-Chuan & Yeh, Chung-Ying, 2010. "Jump and volatility risk premiums implied by VIX," Journal of Economic Dynamics and Control, Elsevier, vol. 34(11), pages 2232-2244, November.
  10. Chen, XiaoHua & Maringer, Dietmar, 2011. "Detecting time-variation in corporate bond index returns: A smooth transition regression model," Journal of Banking & Finance, Elsevier, vol. 35(1), pages 95-103, January.
  11. Hua, Jian & Manzan, Sebastiano, 2013. "Forecasting the return distribution using high-frequency volatility measures," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4381-4403.
  12. Boudt, Kris & Petitjean, Mikael, 2014. "Intraday liquidity dynamics and news releases around price jumps: Evidence from the DJIA stocks," Journal of Financial Markets, Elsevier, vol. 17(C), pages 121-149.
  13. Jang, Bong-Gyu & Yoon, Ji Hee, 2010. "Analytic valuation formulas for range notes and an affine term structure model with jump risks," Journal of Banking & Finance, Elsevier, vol. 34(9), pages 2132-2145, September.
  14. Bulkley, George & Harris, Richard D.F. & Nawosah, Vivekanand, 2011. "Revisiting the expectations hypothesis of the term structure of interest rates," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1202-1212, May.
  15. Li, Junye, 2011. "Volatility components, leverage effects, and the return-volatility relations," Journal of Banking & Finance, Elsevier, vol. 35(6), pages 1530-1540, June.
  16. Sekkel, Rodrigo, 2011. "International evidence on bond risk premia," Journal of Banking & Finance, Elsevier, vol. 35(1), pages 174-181, January.
  17. Evans, Kevin P., 2011. "Intraday jumps and US macroeconomic news announcements," Journal of Banking & Finance, Elsevier, vol. 35(10), pages 2511-2527, October.
  18. Aytek Malkhozov & Philippe Mueller & Andrea Vedolin & Gyuri Venter, 2013. "Mortgage Hedging in Fixed Income Markets," FMG Discussion Papers dp722, Financial Markets Group.
  19. Benoît Sévi & César Baena, 2013. "The explanatory power of signed jumps for the risk-return tradeoff," Economics Bulletin, AccessEcon, vol. 33(2), pages 1029-1046.

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