TY - JOUR
T1 - The Economic Value of Predicting Bond Risk Premia
AU - Sarno, Lucio
AU - Schneider, Paul
AU - Wagner, Christian
PY - 2016/6
Y1 - 2016/6
N2 - 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.
AB - 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.
KW - Term structure of interest rates
KW - Expectations hypothesis
KW - Affine models
KW - Risk premia
KW - Statistical predictability
KW - Economic value
KW - Term structure of interest rates
KW - Expectations hypothesis
KW - Affine models
KW - Risk premia
KW - Statistical predictability
KW - Economic value
U2 - 10.1016/j.jempfin.2016.02.001
DO - 10.1016/j.jempfin.2016.02.001
M3 - Journal article
SN - 0927-5398
VL - 37
SP - 247
EP - 267
JO - Journal of Empirical Finance
JF - Journal of Empirical Finance
ER -