Expected Returns in Treasury Bonds
60 Pages Posted: 15 Nov 2010 Last revised: 2 Apr 2015
Date Written: January 12, 2015
We study risk premium in US Treasury bonds. We decompose Treasury yields into inflation expectations and maturity-specific interest rate cycles, which we define as variation in yields orthogonal to expected inflation. The short-maturity cycle captures the real short-rate dynamics. Jointly with expected inflation, it comprises the expectations hypothesis (EH) term in the yield curve. Controlling for the EH term, we extract a measure of risk premium variation from yields. The risk premium factor forecasts excess bond returns in and out of sample and subsumes the common bond return predictor obtained as a linear combination of forward rates.
Keywords: term premia, bond return forecasting factor
JEL Classification: E43, G12
Suggested Citation: Suggested Citation