IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

The Volatility of Long-term Bond Returns: Persistent Interest Shocks and Time-varying Risk Premiums

  • Daniela Osterrieder

    ()

    (Aarhus University and CREATES)

  • Peter C. Schotman

    ()

    (Maastricht University)

Registered author(s):

    We develop a model that can match two stylized facts of the term-structure. The first stylized fact is the predictability of excess returns on long-term bonds. Modeling this requires sufficient volatility and persistence in the price of risk. The second stylized fact is that long-term yields are dominated by a level factor, which requires persistence in the spot interest rate. We find that a fractionally integrated process for the short rate plus a fractionally integrated specification for the price of risk leads to an analytically tractable almost affine term structure model that can explain the stylized facts. In a decomposition of long-term bond returns we find that the expectations component from the level factor is more volatile than the returns themselves. It therefore takes a volatile risk premium that is negatively correlated with innovations in the level factor to explain the volatility of long-term bond returns. The model also implies that excess bond returns do not exhibit mean reversion, consistent with the empirical evidence.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: ftp://ftp.econ.au.dk/creates/rp/12/rp12_35.pdf
    Download Restriction: no

    Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2012-35.

    as
    in new window

    Length: 51
    Date of creation: 03 Aug 2012
    Date of revision:
    Handle: RePEc:aah:create:2012-35
    Contact details of provider: Web page: http://www.econ.au.dk/afn/

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as in new window
    1. Schotman, Peter & Tschernig, Rolf & Budek, Jan, 2008. "Long Memory and the Term Structure of Risk," University of Regensburg Working Papers in Business, Economics and Management Information Systems 427, University of Regensburg, Department of Economics.
    2. Shiller, Robert J, 1979. "The Volatility of Long-Term Interest Rates and Expectations Models of the Term Structure," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1190-1219, December.
    3. Caroline JARDET & Alain MONFORT & Fulvio PEGORARO, 2011. "No-arbitrage Near-Cointegrated VAR(p) Term Structure Models, Term Premia and GDP Growth," Working Papers 2011-03, Centre de Recherche en Economie et Statistique.
    4. Nielsen, Morten Ørregaard, 2010. "Nonparametric cointegration analysis of fractional systems with unknown integration orders," Journal of Econometrics, Elsevier, vol. 155(2), pages 170-187, April.
    5. Jens H. E. Christensen & Francis X. Diebold & Glenn D. Rudebusch, 2007. "The Affine Arbitrage-Free Class of Nelson-Siegel Term Structure Models," PIER Working Paper Archive 07-029, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    6. Robinson, P.M. & Henry, M., 1999. "Long And Short Memory Conditional Heteroskedasticity In Estimating The Memory Parameter Of Levels," Econometric Theory, Cambridge University Press, vol. 15(03), pages 299-336, June.
    7. Gil-Alana, Luis A. & Moreno, Antonio, 2012. "Uncovering the US term premium: An alternative route," Journal of Banking & Finance, Elsevier, vol. 36(4), pages 1181-1193.
    8. Bekaert, Geert & Hodrick, Robert J. & Marshall, David A., 1997. "On biases in tests of the expectations hypothesis of the term structure of interest rates," Journal of Financial Economics, Elsevier, vol. 44(3), pages 309-348, June.
    9. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
    10. Katsumi Shimotsu, 2006. "Exact Local Whittle Estimation of Fractional Integration with Unknown Mean and Time Trend," Working Papers 1061, Queen's University, Department of Economics.
    11. Campbell, John Y & Shiller, Robert J, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 495-514, May.
    12. Sharon Kozicki & P.A. Tinsley, 1997. "Shifting endpoints in the term structure of interest rates," Research Working Paper 97-08, Federal Reserve Bank of Kansas City.
    13. Diebold, Francis X. & Inoue, Atsushi, 2001. "Long memory and regime switching," Journal of Econometrics, Elsevier, vol. 105(1), pages 131-159, November.
    14. Chen, Willa W. & Hurvich, Clifford M., 2003. "Estimating fractional cointegration in the presence of polynomial trends," Journal of Econometrics, Elsevier, vol. 117(1), pages 95-121, November.
    15. Michael D. Bauer, 2011. "Term premia and the news," Working Paper Series 2011-03, Federal Reserve Bank of San Francisco.
    16. Shimotsu, Katsumi & Phillips, Peter C.B., 2006. "Local Whittle estimation of fractional integration and some of its variants," Journal of Econometrics, Elsevier, vol. 130(2), pages 209-233, February.
    17. Shea, Gary S, 1991. "Uncertainty and Implied Variance Bounds in Long-Memory Models of the Interest Rate Term Structure," Empirical Economics, Springer, vol. 16(3), pages 287-312.
    18. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
    19. Robert F. Stambaugh, 1999. "Predictive Regressions," NBER Technical Working Papers 0240, National Bureau of Economic Research, Inc.
    20. Fabrizio Iacone, 2009. "A Semiparametric Analysis of the Term Structure of the US Interest Rates," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 71(4), pages 475-490, 08.
    21. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-92, September.
    22. Michael D. Bauer & Glenn D. Rudebusch & Jing (Cynthia) Wu, 2011. "Unbiased estimate of dynamic term structure models," Working Paper Series 2011-12, Federal Reserve Bank of San Francisco.
    23. Robert A. Connolly & Z. Nuray Güner & Kenneth N. Hightower, 2007. "Evidence on the Extent and Potential Sources of Long Memory in U.S. Treasury Security Returns and Yields," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(2-3), pages 689-702, 03.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:aah:create:2012-35. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.