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A note on the predictability of excess bond returns and regime shifts

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  • Zhu, Xiaoneng

Abstract

This paper shows that the predictability of excess bond returns could be due to the persistence of regime shifts in interest rate dynamics. This is achieved through the introduction of a regime-dependent heteroscedasticity into the discrete Vasicek model. It therefore provides a new perspective on understanding the predictability of excess returns and the violation of the expectations hypothesis. The model implies that more uncertain the current regime is, more predictable excess returns are. The empirical analysis suggests that regime shifts have forecasting power beyond the predictive power contained in time-varying risk premiums and irrational expectations.

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  • Zhu, Xiaoneng, 2011. "A note on the predictability of excess bond returns and regime shifts," Finance Research Letters, Elsevier, vol. 8(2), pages 101-109, June.
  • Handle: RePEc:eee:finlet:v:8:y:2011:i:2:p:101-109
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    Cited by:

    1. Hassan Shareef & Santhakumar Shijin, 2016. "Expectations Hypothesis and Term Structure of Interest Rates: An Evidence from Emerging Market," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 23(2), pages 137-152, June.
    2. Chen, Son-Nan & Chiang, Mi-Hsiu & Hsu, Pao-Peng & Li, Chang-Yi, 2014. "Valuation of quanto options in a Markovian regime-switching market: A Markov-modulated Gaussian HJM model," Finance Research Letters, Elsevier, vol. 11(2), pages 161-172.

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