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Bond risk premia, priced regime shifts, and macroeconomic fundamentals

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Listed:
  • Constantino Hevia
  • Martín Sola
  • Ivan Petrella

Abstract

In this paper, we develop and estimate an arbitrage-free model of bond prices in which the evolution of the risk factors and the parameters of the stochastic discount factor are subject to occasional discrete changes in regimes. We show that the component of risk premia associated with regime shifts is related to the macroeconomic environment. In particular, the explicit pricing of regime shifts and the nonlinearities associated with the Markov switching model generates a strong connection between bond risk premia and the macroeconomy as summarized by variables such as inflation, industrial production, and unemployment.

Suggested Citation

  • Constantino Hevia & Martín Sola & Ivan Petrella, 2022. "Bond risk premia, priced regime shifts, and macroeconomic fundamentals," Department of Economics Working Papers 2022_03, Universidad Torcuato Di Tella.
    • Handle: RePEc:udt:wpecon:2022_03
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    References listed on IDEAS

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    More about this item

    Keywords

    Bubbles; Explosiveness; Markov-switching autoregressive model; Unit-root test.;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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