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Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity

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  • Carolin E. Pflueger
  • Luis M. Viceira

Abstract

Estimating the liquidity differential between inflation-indexed and nominal bond yields, we separately test for time-varying real rate risk premia, inflation risk premia, and liquidity premia in U.S. and U.K. bond markets. We find strong, model independent evidence that real rate risk premia and inflation risk premia contribute to nominal bond excess return predictability to quantitatively similar degrees. The estimated liquidity premium between U.S. inflation-indexed and nominal yields is systematic, ranges from 30 bps in 2005 to over 150 bps during 2008-2009, and contributes to return predictability in inflation-indexed bonds. We find no evidence that bond supply shocks generate return predictability.

Suggested Citation

  • Carolin E. Pflueger & Luis M. Viceira, 2011. "Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity," NBER Working Papers 16892, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:16892
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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