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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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16892.

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Date of creation: Mar 2011
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Handle: RePEc:nbr:nberwo:16892

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Cited by:
  1. Paolo Manasse & Luca Zavalloni, 2013. "Sovereign Contagion in Europe: Evidence from the CDS Market," Working Papers 471, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  2. Breedon, Francis, 2012. "A variance decomposition of index-linked bond returns," Economics Letters, Elsevier, vol. 116(1), pages 49-51.
  3. Jens H.E. Christensen & James M. Gillan, 2011. "A model-independent maximum range for the liquidity correction of TIPS yields," Working Paper Series 2011-16, Federal Reserve Bank of San Francisco.
  4. Matthew Canzoneri & Robert Cumby & Behzad Diba, 2012. "Monetary policy and the natural rate of interest," BIS Papers chapters, in: Bank for International Settlements (ed.), Threat of fiscal dominance?, volume 65, pages 119-134 Bank for International Settlements.

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