Term structure determinants of time‐varying risk of 1‐year bond returns

Term structure drivers of 1‐year bond premia and conditional bond return risk are distinct. Consequently, the Cochrane–Piazzesi factor captures aggregate price of risk and not the amount of risk in 1‐year bond returns. One linear combination of forward rates captures most of the variation in bond return risk across maturities. Interest rate level captures substantial amount of variation in the conditional return risk, a finding consistent with rising inflation uncertainty with level of inflation and interest rates. The 4‐5 yield spread, an important positive predictor of bond return premia, has an opposing but limited impact on the conditional volatility.