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Mind the (Convergence) Gap: Bond Predictability Strikes Back!

Author

Listed:
  • Andrea Berardi

    (Ca Foscari University of Venice - Dipartimento di Economia)

  • Michael Markovich

    (Investment Strategy - Private Banking Wealth Management; Vienna Institute of Finance)

  • Alberto Plazzi

    (Swiss Finance Institute; USI Lugano)

  • Andrea Tamoni

    (Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick; London School of Economics & Political Science (LSE))

Abstract

We show that the difference between the natural rate of interest and the current level of monetary policy stance, dubbed Convergence Gap (CG), contains information that is valuable for bond predictability. Adding CG in forecasting regressions of bond excess returns significantly raises the R-squared, and restores countercyclical variation in bond risk premia that is otherwise missed by forward rates. The convergence gap also predicts changes in future yields, and consistently plays the role of an unspanned variable within an affine term structure framework. The importance of the gap remains robust out-of-sample, and in countries other than the U.S. Furthermore, its inclusion brings significant economic gains in the context of dynamic conditional asset allocation.

Suggested Citation

  • Andrea Berardi & Michael Markovich & Alberto Plazzi & Andrea Tamoni, 2019. "Mind the (Convergence) Gap: Bond Predictability Strikes Back!," Swiss Finance Institute Research Paper Series 19-52, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1952
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    More about this item

    Keywords

    Bond Risk Premia; Forward Rates; Monetary Policy; Natural Rate of Interest; Bond Predictability;
    All these keywords.

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G0 - Financial Economics - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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