The Economic Value of Predicting Bond Risk Premia

Lucio Sarno, Paul Schneider, Christian Wagner

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

This paper studies whether the evident statistical predictability of bond risk premia translates into economic gains for investors. We propose a novel estimation strategy for affine term structure models that jointly fits yields and bond excess returns, thereby capturing predictive information otherwise hidden to standard estimations. The model predicts excess returns with high regression R2s and high forecast accuracy but cannot outperform the expectations hypothesis out-of-sample in terms of economic value, showing a general contrast between statistical and economic metrics of forecast evaluation. More specifically, the model mostly generates positive (negative) economic value during times of high (low) macroeconomic uncertainty. Overall, the expectations hypothesis remains a useful benchmark for investment decisions in bond markets, especially in low uncertainty states.
This paper studies whether the evident statistical predictability of bond risk premia translates into economic gains for investors. We propose a novel estimation strategy for affine term structure models that jointly fits yields and bond excess returns, thereby capturing predictive information otherwise hidden to standard estimations. The model predicts excess returns with high regression R2s and high forecast accuracy but cannot outperform the expectations hypothesis out-of-sample in terms of economic value, showing a general contrast between statistical and economic metrics of forecast evaluation. More specifically, the model mostly generates positive (negative) economic value during times of high (low) macroeconomic uncertainty. Overall, the expectations hypothesis remains a useful benchmark for investment decisions in bond markets, especially in low uncertainty states.
LanguageEnglish
JournalJournal of Empirical Finance
Volume37
Pages247–267
ISSN0927-5398
DOIs
StatePublished - Jun 2016

Keywords

  • Term structure of interest rates
  • Expectations hypothesis
  • Affine models
  • Risk premia
  • Statistical predictability
  • Economic value

Cite this

Sarno, Lucio ; Schneider, Paul ; Wagner, Christian. / The Economic Value of Predicting Bond Risk Premia. In: Journal of Empirical Finance. 2016 ; Vol. 37. pp. 247–267
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The Economic Value of Predicting Bond Risk Premia. / Sarno, Lucio; Schneider, Paul; Wagner, Christian.

In: Journal of Empirical Finance, Vol. 37, 06.2016, p. 247–267.

Research output: Contribution to journalJournal articleResearchpeer-review

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