Finance and Economics Discussion Series (FEDS)

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May 2019

Bond Risk Premiums at the Zero Lower Bound

Martin M. Andreasen, Kasper Jørgensen, and Andrew Meldrum

Abstract:

This paper documents a significantly stronger relationship between the slope of the yield curve and future excess bond returns on Treasuries from 2008-2015 than before 2008. This new predictability result is not matched by the standard shadow rate model with Gaussian factor dynamics, but extending the model with regime-switching in the (physical) dynamics of the factors at the lower bound resolves this shortcoming. The model is also consistent with the downwards trend in surveys on short rate expectations at long horizons, but requires a break in the level of its factors to closely fit the low level of these surveys since 2015.

Accessible version (.zip)

Keywords: Dynamic term structure model, bond return predictability, regime-switching, shadow rate model, structural break

DOI: https://doi.org/10.17016/FEDS.2019.040

PDF: Full Paper

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Last Update: January 09, 2020