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Information in (and not in) the term structure

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  • Greg Duffee

Abstract

Standard approaches to building and estimating dynamic term structure models rely on the assumption that yields can serve as the factors. However, the assumption is neither theoretically necessary nor empirically supported. This paper documents that almost half of the variation in bond risk premia cannot be detected using the cross section of yields. Fluctuations in this hidden component have strong forecast power for both future short-term interest rates and excess bond returns. They are also negatively correlated with aggregate economic activity, but macroeconomic variables explain only a small fraction of variation in the hidden factor.

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Bibliographic Info

Paper provided by The Johns Hopkins University,Department of Economics in its series Economics Working Paper Archive with number 577.

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Date of creation: Jan 2011
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Handle: RePEc:jhu:papers:577

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  1. Ang, Andrew & Piazzesi, Monika & Wei, Min, 2006. "What does the yield curve tell us about GDP growth?," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 359-403.
  2. Gurkaynak, Refet S. & Sack, Brian & Wright, Jonathan H., 2007. "The U.S. Treasury yield curve: 1961 to the present," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2291-2304, November.
  3. Greg Duffee, 2011. "Forecasting with the term structure: The role of no-arbitrage restrictions," Economics Working Paper Archive 576, The Johns Hopkins University,Department of Economics.
  4. Greg Duffee, 2010. "Sharpe ratios in term structure models," Economics Working Paper Archive 575, The Johns Hopkins University,Department of Economics.
  5. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
  6. Pennacchi, George G, 1991. "Identifying the Dynamics of Real Interest Rates and Inflation: Evidence Using Survey Data," Review of Financial Studies, Society for Financial Studies, vol. 4(1), pages 53-86.
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