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Term Premium Determinants

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  • Carlos Del Castillo
  • Jean-François Fillion
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    Abstract

    Forward interest rates provide public authorities with insight into financial market expectations of future interest rates. Quite often the Expectation Hypothesis of the Term Structure (EHTS) is used to explain changes in forward interest rates. The EHTS assumes that forward rates, when adjusted for a term premium, are unbiased predictors of anticipated future interest rates. That said, it is well known that the EHTS is often rejected by the data, perhaps because the term premium varies over time. In this paper, we develop a consumption-based asset pricing model aimed at explaining the term premium included in the three-month forward rate. In the model, the premium depends on two parameters — the degree of consumer’s risk aversion and the persistence of consumption growth — and on one variable — the conditional variance of consumption growth. We then test the role of the conditional variance of consumption growth using an econometric equation for the term premium. The EHTS is not rejected in a broad equation that includes the conditional variance of consumption growth and a measure of the federal government debt-to-GDP ratio as a proxy for the time-varying risk premium often associated with changes in government debt. Using this equation, we find that the term premium for the three-month forward interest rate has dropped by about 50 basis points since its recent peak in 1995 following the decline in the government debt-to-GDP ratio. Les taux d’intérêt à terme contiennent de l’information utile pour les autorités publiques en ce qui a trait aux taux d’intérêt futurs anticipés par les marchés financiers. Pour expliquer l’évolution des taux d’intérêt à terme, il n’est pas rare d’utiliser l’hypothèse des attentes de la structure par terme des taux d’intérêt (HASTI). Cette hypothèse suppose que les taux à terme, lorsque ajustés pour la prime à terme, sont des mesures non-biaisées des taux d’intérêt futurs anticipés. Or, il est bien connu que l’HASTI est le plus souvent rejetée par les données, peut-être parce que la prime à terme est variable dans le temps. Dans ce travail, nous développons un modèle théorique d’évaluation d’actif basé sur la consommation visant à expliquer la prime à terme comprise dans le taux à terme à trois mois. Dans le modèle, la prime dépend de deux paramètres – le degré d’aversion au risque du consommateur et le degré de persistance du taux de croissance de la consommation – ainsi que d’une variable, soit la variance conditionnelle du taux de croissance de la consommation. Nous vérifions ensuite le rôle de la variance conditionnelle de la consommation dans un équation économétrique de la prime à terme. L’HASTI n’est pas rejetée dans une équation élargie comprenant la variance conditionnelle du taux de croissance de la consommation et le ratio de la dette du gouvernement fédéral au PIB, lequel représente ici une mesure d’approximation pour les variations de la prime de risque souvent associées aux changements de l’endettement public. Avec cette équation, nous trouvons que la prime à terme du taux d’intérêt à terme à trois mois a baissé d’environ 50 points de base depuis son récent sommet de 1995 en raison de la diminution de l’endettement public.

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    Bibliographic Info

    Paper provided by Department of Finance Canada in its series Working Papers-Department of Finance Canada with number 2002-08.

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    Handle: RePEc:fca:wpfnca:2002-08

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