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Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity

  • Carolin E. Pflueger

    ()

    (University of British Columbia)

  • Luis M. Viceira

    ()

    (Harvard Business School, Finance Unit)

Estimating the liquidity differential between inflation-indexed and nominal bond yields, we separately test for time-varying real rate risk premia, inflation risk premia, and liquidity premia in U.S. and U.K. bond markets. We find strong, model independent evidence that real rate risk premia and inflation risk premia contribute to nominal bond excess return predictability to quantitatively similar degrees. The estimated liquidity premium between U.S. inflation-indexed and nominal yields is systematic, ranges from 30 bps in 2005 to over 150 bps during 2008-2009, and contributes to return predictability in inflation-indexed bonds. We find no evidence that bond supply shocks generate return predictability.

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File URL: http://www.hbs.edu/faculty/pages/download.aspx?name=11-094.pdf
File Function: Revised version, 2013
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Paper provided by Harvard Business School in its series Harvard Business School Working Papers with number 11-094.

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Length: 51 pages
Date of creation: Mar 2011
Date of revision: Sep 2013
Handle: RePEc:hbs:wpaper:11-094
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