Risk and Return in Government Bonds

Does the compensation investors require for holding government bonds vary with their risk? We measure expected excess returns using market yields and professional forecasts of future yields, showing that they are tightly linked to a standard measure of risk: bonds’ betas with respect to the stock market. In a month-by-maturity panel of U. S. Treasuries from 1988 to 2024, the correlation between expected excess returns and bond–stock betas is 67%. The correlation is driven by variation in market yields rather than forecasters’ expectations. The relationship between realized excess returns and betas is weak in a univariate regression, but it becomes economically large and significant when we control for monetary-policy and macroeconomic forecast errors. Similar results obtain in an international panel of developed countries from 1989 to 2024. Our findings suggest that variation in risk premia driven by changing bond risk accounts for more than half of both the decline in U.S. long-term bond yields since the mid-1980s and their increase since 2020.