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On the Factor Structure of Bond Returns

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  • Richard K. Crump
  • Nikolay Gospodinov

Abstract

We demonstrate that characterizing the minimal dimension of the term structure of interest rates is more challenging than currently appreciated. The highly structured polynomial patterns of the factor loadings, which are widely reported and discussed in the literature, reflect local correlations of smooth curves across maturities. We derive analytical expressions for the loadings of cross‐sectionally dependent processes that tend to favor a much lower dimension than the true dimension of the underlying factor space. Numerical examples illustrate the significant economic costs of erroneously committing to a parsimoniously parameterized factor space that is informed by standard metrics of goodness‐of‐fit. Our results apply to other assets with a finite maturity structure.

Suggested Citation

  • Richard K. Crump & Nikolay Gospodinov, 2022. "On the Factor Structure of Bond Returns," Econometrica, Econometric Society, vol. 90(1), pages 295-314, January.
    • Handle: RePEc:wly:emetrp:v:90:y:2022:i:1:p:295-314
    DOI: 10.3982/ECTA17943
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    References listed on IDEAS

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    Cited by:

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    2. Pablo Guerrón-Quintana & Alexey Khazanov & Molin Zhong, 2023. "Financial and Macroeconomic Data Through the Lens of a Nonlinear Dynamic Factor Model," Finance and Economics Discussion Series 2023-027, Board of Governors of the Federal Reserve System (U.S.).
    3. Kleibergen, Frank & Kong, Lingwei, 2025. "Identification robust inference for the risk premium in term structure models," Journal of Econometrics, Elsevier, vol. 248(C).
    4. Dennis Schroers, 2024. "Robust Functional Data Analysis for Stochastic Evolution Equations in Infinite Dimensions," Papers 2401.16286, arXiv.org, revised Sep 2025.
    5. Kirsten, Oliver & Süssmuth, Bernd, 2025. "Forecasting the unforecastable: An independent component analysis for majority game-like global cryptocurrencies," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 665(C).
    6. Dennis Schroers, 2024. "Dynamically Consistent Analysis of Realized Covariations in Term Structure Models," Papers 2406.19412, arXiv.org.
    7. Jungbin Hwang & Feifan Wang, 2025. "Sieve Bootstrap Approach to Robust Term Premia Analysis," Working papers 2025-10, University of Connecticut, Department of Economics.
    8. Prosper Dovonon & Nikolay Gospodinov, 2024. "Specification testing for conditional moment restrictions under local identification failure," Quantitative Economics, Econometric Society, vol. 15(3), pages 849-891, July.
    9. Andreas Schrimpf & Markus Sihvonen, 2025. "Inflation and the joint bond-FX spanning puzzle," BIS Working Papers 1320, Bank for International Settlements.

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