Hostname: page-component-76fb5796d-zzh7m Total loading time: 0 Render date: 2024-04-27T02:09:27.280Z Has data issue: false hasContentIssue false
  • English
  • Français

Expected Business Conditions and Bond Risk Premia

Published online by Cambridge University Press:  21 June 2017

Jonas N. Eriksen
Get access Rights & Permissions [Opens in a new window]

Abstract

In this article, I study the predictability of bond risk premia by means of expectations to future business conditions using survey forecasts from the Survey of Professional Forecasters. I show that expected business conditions consistently affect excess bond returns and that the inclusion of expected business conditions in standard predictive regressions improve forecast performance relative to models using information derived from the current term structure or macroeconomic variables. The results are confirmed in a real-time out-of-sample exercise, where the predictive accuracy of the models is evaluated both statistically and from the perspective of a mean-variance investor that trades in the bond market.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 52 , Issue 4 , August 2017 , pp. 1667 - 1703
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

I am grateful to an anonymous referee, Paul Malatesta (the editor), Stig V. Møller, Thomas Q. Pedersen, Jesper Rangvid, Maik Schmeling, Andreas Schrimpf, and seminar participants at Aarhus University and CREATES and the 2015 Nordic Econometric Meeting in Helsinki for helpful comments and suggestions. I acknowledge support from CREATES (Center for Research in Econometric Analysis of Time Series) (DNRF78), funded by the Danish National Research Foundation.

References

Almeida, C.; Graveline, J. J.; and Joslin, S.. “Do Interest Rate Options Contain Information About Excess Returns?” Journal of Econometrics, 164 (2011), 35–44.Google Scholar
Altavilla, C.; Giacomini, R.; and Constantini, R.. “Bond Returns and Market Expectations.” Journal of Financial Econometrics, 12 (2014), 708–729.Google Scholar
Amato, J. D., and Swanson, N. R.. “The Real-Time Predictive Content of Money for Output.” Journal of Monetary Economics, 48 (2001), 3–24.Google Scholar
Andersen, T. G., and Benzoni, L.. “Do Bonds Span Volatility Risk in the U.S. Treasury Market? A Specification Test for Affine Term Structure Models.” Journal of Finance, 65 (2010), 603–653.Google Scholar
Andreasen, M. M.; Engsted, T.; Møller, S. V.; and Sander, M.. “Bond Market Asymmetries Across Recessions and Expansions: New Evidence on Risk Premia.” CREATES Research Paper 2016-26 (2016).CrossRefGoogle Scholar
Ang, A.; Bekaert, G.; and Wei, M.. “Do Macro Variables, Asset Markets, or Surveys Forecast Inflation Better?” Journal of Monetary Economics, 54 (2007), 1163–1212.Google Scholar
Ang, A.; Dong, S.; and Piazzesi, M.. “No-Arbitrage Taylor Rules.” Working Paper, Columbia University (2007).Google Scholar
Ang, A., and Piazzesi, M.. “A No-Arbitrage Vector Autoregression of the Term Structure Dynamics with Macroeconomic and Latent Variables.” Journal of Monetary Economics, 50 (2003), 745–787.Google Scholar
Bai, J., and Ng, S.. “Determining the Number of Factors in Approximate Factor Models.” Econometrica, 70 (2002), 135–172.Google Scholar
Bai, J., and Ng, S.. “Forecasting Economic Time Series Using Targeted Predictors.” Journal of Econometrics, 146 (2008), 304–317.Google Scholar
Bansal, R., and Shaliastovich, I.. “A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets.” Review of Financial Studies, 26 (2013), 1–33.Google Scholar
Bansal, R., and Yaron, A.. “Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles.” Journal of Finance, 59 (2004), 1481–1509.CrossRefGoogle Scholar
Barro, R. J.“The Stock Market and Investment.” Review of Financial Studies, 3 (1990), 115–131.Google Scholar
Bates, J. M., and Granger, C. W. J.. “The Combination of Forecasts.” Operational Research Quarterly, 20 (1969), 451–468.CrossRefGoogle Scholar
Bikbov, R., and Chernov, M.. “No-Arbitrage Macroeconomic Determinants of the Yield Curve.” Journal of Econometrics, 159 (2010), 166–182.Google Scholar
Buraschi, A., and Jiltsov, A.. “Habit Formation and Macroeconomic Models of the Term Structure of Interest Rates.” Journal of Finance, 62 (2007), 3009–3063.Google Scholar
Campbell, J. Y., and Ammer, J.. “What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns.” Journal of Finance, 48 (1993), 3–37.Google Scholar
Campbell, J. Y., and Cochrane, J. H.. “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior.” Journal of Political Economy, 107 (1999), 205–251.Google Scholar
Campbell, S. D., and Diebold, F. X.. “Stock Returns and Expected Business Conditions: Half a Century of Direct Evidence.” Journal of Business and Economic Statistics, 27 (2009), 266–278.Google Scholar
Campbell, J. Y., and Shiller, R. J.. “Yield Spreads and Interest Rate Movements: A Bird’s Eye View.” Review of Economic Studies, 58 (1991), 495–514.Google Scholar
Campbell, J. Y., and Thompson, S. B.. “Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?” Review of Financial Studies, 21 (2008), 1509–1531.Google Scholar
Capistrán, C., and Timmermann, A.. “Forecast Combination with Entry and Exist of Experts.” Journal of Business and Economic Statistics, 27 (2009), 428–440.Google Scholar
Chen, N.-F.; Roll, R.; and Ross, S. A.. “Economic Forces and the Stock Market.” Journal of Business, 59 (1986), 383–403.Google Scholar
Chernov, M., and Mueller, P.. “The Term Structure of Inflation Expectations.” Journal of Financial Economics, 106 (2012), 367–394.CrossRefGoogle Scholar
Chun, A. L.“Expectations, Bond Yields, and Monetary Policy.” Review of Financial Studies, 24 (2011), 208–247.Google Scholar
Cieslak, A., and Povala, P.. “Expected Returns in Treasury Bonds.” Review of Financial Studies, 28 (2015), 2859–2901.Google Scholar
Clark, T. E., and West, K. D.. “Approximately Normal Tests for Equal Predictive Accuracy in Nested Models.” Journal of Econometrics, 138 (2007), 291–311.Google Scholar
Cochrane, J. H., and Piazzesi, M.. “Bond Risk Premia.” American Economic Review, 95 (2005), 138–160.Google Scholar
Cooper, I., and Priestley, R.. “Time-Varying Risk Premiums and the Output Gap.” Review of Financial Studies, 22 (2009), 2801–2833.Google Scholar
Croushore, D., and Stark, T.. “A Real-Time Data Set for Macroeconomists.” Journal of Econometrics, 105 (2001), 111–130.Google Scholar
Dahlquist, M., and Hasseltoft, H.. “International Bond Risk Premia.” Journal of International Economics, 90 (2013), 17–32.Google Scholar
Dangl, T., and Halling, M.. “Predictive Regressions with Time-Varying Coefficients.” Journal of Financial Economics, 106 (2012), 157–181.Google Scholar
Dick, C. D.; Schmeling, M.; and Schrimpf, A.. “Macro-Expectations, Aggregate Uncertainty, and Expected Term Premia.” European Economic Review, 58 (2013), 58–80.Google Scholar
Diebold, F. X., and Mariano, R. S.. “Comparing Predictive Accuracy.” Journal of Business and Economic Statistics, 13 (1995), 253–265.Google Scholar
Duffee, G. R.“Information in (and Not in) the Term Structure.” Review of Financial Studies, 24 (2011), 2895–2934.Google Scholar
Fama, E.“Stock Returns, Expected Returns, and Real Activity.” Journal of Finance, 45 (1990), 1089–1108.Google Scholar
Fama, E.“The Behavior of Interest Rates.” Review of Financial Studies, 19 (2006), 359–379.Google Scholar
Fama, E. F., and Bliss, R. R.. “The Information in Long-Maturity Forward Rates.” American Economic Review, 77 (1987), 680–692.Google Scholar
Fama, E., and French, K.. “Business Conditions and Expected Returns on Stocks and Bonds.” Journal of Financial Economics, 25 (1989), 23–49.CrossRefGoogle Scholar
Fama, E. F., and Gibbons, M. R.. “A Comparison of Inflation Forecasts.” Journal of Monetary Economics, 13 (1984), 327–348.CrossRefGoogle Scholar
Fama, E., and Schwert, G. W.. “Asset Returns and Inflation.” Journal of Financial Economics, 5 (1977), 115–146.Google Scholar
Favero, C. A.; Niu, L.; and Sala, L.. “Term Structure Forecasting: No-Arbitrage Restriction versus Large Information Set.” Journal of Forecasting, 31 (2012), 124–156.Google Scholar
Ferson, W. E., and Harvey, C. R.. “The Variation of Economic Risk Premiums.” Journal of Political Economy, 99 (1991), 385–415.Google Scholar
Froot, K. A.“New Hope for the Expectations Hypothesis of the Term Structure of Interest Rates.” Journal of Finance, 44 (1989), 283–305.Google Scholar
Gargano, A.; Pettenuzzo, D.; and Timmermann, A.. “Bond Return Predictability: Economic Value and Links to the Macroeconomy.” Working Paper, University of California, San Diego (2017).Google Scholar
Ghysels, E.; Horan, C.; and Moench, E.. “Forecasting through the Rear-View Mirror: Data Revisions and Bond Return Predictability.” Federal Reserve Bank of New York Staff Report No. 581 (2014).Google Scholar
Goetzmann, W.; Ingersoll, J.; Spiegel, M.; and Welch, I.. “Portfolio Performance Manipulation and Manipulation-Proof Performance Measures.” Review of Financial Studies, 20 (2007), 1503–1546.Google Scholar
Goyal, A., and Welch, I.. “A Comprehensive Look at the Empirical Performance of Equity Premium Prediction.” Review of Financial Studies, 21 (2008), 1455–1508.Google Scholar
Gürkaynak, R. S.; Sack, B.; and Wright, J. H.. “The U.S. Treasury Yield Curve: 1961 to the Present.” Journal of Monetary Economics, 54 (2007), 2291–2304.CrossRefGoogle Scholar
Hansen, L. P., and Hodrick, R. J.. “Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis.” Journal of Political Economy, 88 (1980), 829–853.Google Scholar
Henkel, S. J.; Martin, J. S.; and Nardari, F.. “Time-Varying Short-Horizon Predictability.” Journal of Financial Economics, 99 (2011), 560–580.Google Scholar
Ilmanen, A.“Time-Varying Expected Returns in International Bond Markets.” Journal of Finance, 50 (1995), 481–506.Google Scholar
Inoue, A., and Kilian, L.. “In-Sample or Out-of-Sample Tests of Predictability: Which One Should We Use?” Econometric Review, 23 (2005), 371–402.Google Scholar
Joslin, S.; Priebsch, M.; and Singleton, K. J.. “Risk Premiums in Dynamic Term Structure Models with Unspanned Macro Risks.” Journal of Finance, 69 (2014), 1197–1233.Google Scholar
Jurado, K.; Ludvgison, S. C.; and Ng, S.. “Measuring Uncertainty.” American Economic Review, 105 (2015), 1177–1216.Google Scholar
Keim, D. B., and Stambaugh, R. F.. “Predicting Returns in the Stock and Bond Markets.” Journal of Financial Economics, 17 (1986), 357–390.Google Scholar
Litterman, R., and Scheinkman, J.. “Common Factors Affecting Bond Returns.” Journal of Fixed Income, 1 (1991), 54–61.CrossRefGoogle Scholar
Ludvigson, S. C., and Ng, S.. “Macro Factors in Bond Risk Premia.” Review of Financial Studies, 22 (2009), 5027–5067.Google Scholar
McCracken, M. W., and Ng, S.. “FRED-MD: A Monthly Database for Macroeconomic Research.” Federal Reserve Bank of St. Louis Working Paper Series (2015).Google Scholar
Merton, R. C.“An Intertemporal Capital Asset Pricing Model.” Econometrica, 41 (1973), 867–887.Google Scholar
Moench, E.“Forecasting the Yield Curve and a Data-Rich Environment: A No-Arbitrage Factor-Augmented VAR Approach.” Journal of Econometrics, 146 (2008), 26–43.Google Scholar
Møller, S. V., and Sander, M.. “Stock Return and Dividend Growth Predictability Across the Business Cycle.” Working Paper, Aarhus University (2015).Google Scholar
Nelson, C. R., and Siegel, A. F.. “Parsimonious Modeling of Yield Curves.” Journal of Business, 60 (1987), 473–489.Google Scholar
Newey, W. K., and West, K. D.. “A Simple Positive-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703–708.Google Scholar
Ottaviani, M., and Sørensen, P. N.. “The Strategy of Professional Forecasting.” Journal of Financial Economics, 81 (2006), 441–466.Google Scholar
Pesaran, M. H., and Timmermann, A.. “Real Time Econometrics.” Econometric Theory, 21 (2005), 212–231.Google Scholar
Piazzesi, M.; Salomao, J.; and Schneider, M.. “Trend and Cycle in Bond Premia.” Working Paper, Stanford (2015).Google Scholar
Rapach, D.; Strauss, J. K.; and Zhou, G.. “Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy.” Review of Financial Studies, 23 (2010), 821–862.Google Scholar
Rapach, D., and Zhou, G.. “Forecasting Stock Returns.” In Handbook of Economic Forecasting, Vol. 2, Elliott, G. and Timmermann, A., eds. Amsterdam, The Netherlands: Elsevier (2013), 328–383.Google Scholar
Rossi, A. G., and Timmermann, A.. “Modeling Covariance Risk in Merton’s ICAMP.” Review of Financial Studies, 28 (2015), 1428–1461.Google Scholar
Rudebusch, G. D., and Wu, T.. “A Macro-Finance Model of the Term Structure, Monetary Policy and the Economy.” Economic Journal, 118 (2008), 906–926.Google Scholar
Sarno, L.; Schneider, P.; and Wagner, C.. “The Economic Value of Predicting Bond Risk Premia.” Journal of Empirical Finance, 37 (2016), 247–267.Google Scholar
Schmeling, M., and Schrimpf, A.. “Expected Inflation, Expected Stock Returns, and Money Illusion: What Can We Learn from Survey Expectations?” European Economic Review, 55 (2011), 702–719.CrossRefGoogle Scholar
Stock, J. H., and Watson, M. W.. “Forecasting Inflation.” Journal of Monetary Economics, 44 (1999), 293–335.CrossRefGoogle Scholar
Stock, J. H., and Watson, M. W.. “Forecasting Using Principal Components from a Large Number of Predictors.” Journal of the American Statistical Association, 97 (2002a), 1167–1179.CrossRefGoogle Scholar
Stock, J. H., and Watson, M. W.. “Macroeconomic Forecasting Using Diffusion Indexes.” American Statistical Association, 20 (2002b), 147–162.Google Scholar
Svensson, L. E. O.“Estimating and Interpreting Forward Interest Rates: Sweden 1992–1994.” National Bureau of Economic Research Working Paper No. 4871 (1994).Google Scholar
Thomas, L. B.“Survey Measures of Expected U.S. Inflation.” Journal of Economic Perspectives, 13 (1999), 125–144.CrossRefGoogle Scholar
Thornton, D. L., and Valente, G.. “Out-of-Sample Predictions of Bond Excess Returns and Forward Rates: An Asset Allocation Perspective.” Review of Financial Studies, 25 (2012), 3141–3168.Google Scholar
Timmermann, A.“Forecast Combination.” In Handbook of Economic Forecasting, Vol. 1, Elliot, G., Granger, C., and Timmermann, A., eds. Amsterdam, The Netherlands: Elsevier (2006), 135–196.Google Scholar
Wachter, J. A.“A Consumption-Based Model of the Term Structure of Interest Rates.” Journal of Financial Economics, 79 (2006), 365–399.CrossRefGoogle Scholar
Wright, J. H.“Term Premia and Inflation Uncertainty: Empirical Evidence from an International Panel Dataset.” American Economic Review, 101 (2011), 1514–1534.Google Scholar
Wright, J. H., and Zhou, H.. “Bond Risk Premia and Realized Jump Risk.” Journal of Banking and Finance, 33 (2009), 2333–2345.Google Scholar
Zhou, G., and Zhu, X.. “Bond Return Predictability and Macroeconomy: The International Link.” Working Paper, Washington University in St. Louis (2016).Google Scholar
Zhu, X.“Out-of-Sample Bond Premium Predictions: A Global Common Factor.” Journal of International Money and Finance, 51 (2015), 155–173.Google Scholar
Supplementary material: File

Eriksen supplementary material

Eriksen supplementary material

Download Eriksen supplementary material(File)
File 2.6 MB