The Economic Value of Predicting Bond Risk Premia: Can Anything Beat the Expectations Hypothesis?

Lucio Sarno, Paul Schneider, Christian Wagner

Research output: Contribution to conferencePaperResearch

Abstract

This paper studies whether the evident statistical predictability of bond risk
premia translates into economic gains for bond investors. We show that ane
term structure models (ATSMs) estimated by jointly tting yields and bond excess
returns capture this predictive information otherwise hidden to standard ATSM
estimations. The model's excess return predictions are unbiased, produce regression R2s beyond those reported in the literature, exhibit high forecast accuracy, and allow to generate positive bond portfolio excess returns in- and out-of-sample. Nevertheless, these models cannot beat the expectations hypothesis (EH) out-ofsample: the forecasts do not add economic value compared to using the average historical excess return as an EH-consistent estimate of constant risk premia. We show that in general statistical signicance does not necessarily translate into economic signicance because EH deviations mainly matter at short horizons and standard predictability metrics are not compatible with common measures of economic value. Overall, the EH remains the benchmark for investment decisions and should be considered an economic prior in models of bond risk premia.
This paper studies whether the evident statistical predictability of bond risk
premia translates into economic gains for bond investors. We show that ane
term structure models (ATSMs) estimated by jointly tting yields and bond excess
returns capture this predictive information otherwise hidden to standard ATSM
estimations. The model's excess return predictions are unbiased, produce regression R2s beyond those reported in the literature, exhibit high forecast accuracy, and allow to generate positive bond portfolio excess returns in- and out-of-sample. Nevertheless, these models cannot beat the expectations hypothesis (EH) out-ofsample: the forecasts do not add economic value compared to using the average historical excess return as an EH-consistent estimate of constant risk premia. We show that in general statistical signicance does not necessarily translate into economic signicance because EH deviations mainly matter at short horizons and standard predictability metrics are not compatible with common measures of economic value. Overall, the EH remains the benchmark for investment decisions and should be considered an economic prior in models of bond risk premia.

Seminar

SeminarResearch Seminar
LocationUniversität Innsbruck, Institut für Banken und Finanzen
CountryAustria
CityInnsbruck
Period14/01/201314/01/2013
Internet address

Keywords

    Cite this

    Sarno, L., Schneider, P., & Wagner, C. (2013). The Economic Value of Predicting Bond Risk Premia: Can Anything Beat the Expectations Hypothesis?. Paper presented at Research Seminar, Innsbruck, Austria.DOI: 10.2139/ssrn.2005178
    Sarno, Lucio ; Schneider, Paul ; Wagner, Christian. / The Economic Value of Predicting Bond Risk Premia : Can Anything Beat the Expectations Hypothesis?. Paper presented at Research Seminar, Innsbruck, Austria.36 p.
    @conference{7703435b1f95459cb34660d835ac110b,
    title = "The Economic Value of Predicting Bond Risk Premia: Can Anything Beat the Expectations Hypothesis?",
    abstract = "This paper studies whether the evident statistical predictability of bond riskpremia translates into economic gains for bond investors. We show that aneterm structure models (ATSMs) estimated by jointly tting yields and bond excessreturns capture this predictive information otherwise hidden to standard ATSMestimations. The model's excess return predictions are unbiased, produce regression R2s beyond those reported in the literature, exhibit high forecast accuracy, and allow to generate positive bond portfolio excess returns in- and out-of-sample. Nevertheless, these models cannot beat the expectations hypothesis (EH) out-ofsample: the forecasts do not add economic value compared to using the average historical excess return as an EH-consistent estimate of constant risk premia. We show that in general statistical signicance does not necessarily translate into economic signicance because EH deviations mainly matter at short horizons and standard predictability metrics are not compatible with common measures of economic value. Overall, the EH remains the benchmark for investment decisions and should be considered an economic prior in models of bond risk premia.",
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    Sarno, L, Schneider, P & Wagner, C 2013, 'The Economic Value of Predicting Bond Risk Premia: Can Anything Beat the Expectations Hypothesis?' Paper presented at, Innsbruck, Austria, 14/01/2013 - 14/01/2013, . DOI: 10.2139/ssrn.2005178

    The Economic Value of Predicting Bond Risk Premia : Can Anything Beat the Expectations Hypothesis? / Sarno, Lucio ; Schneider, Paul ; Wagner, Christian.

    2013. Paper presented at Research Seminar, Innsbruck, Austria.

    Research output: Contribution to conferencePaperResearch

    TY - CONF

    T1 - The Economic Value of Predicting Bond Risk Premia

    T2 - Can Anything Beat the Expectations Hypothesis?

    AU - Sarno,Lucio

    AU - Schneider,Paul

    AU - Wagner,Christian

    PY - 2013

    Y1 - 2013

    N2 - This paper studies whether the evident statistical predictability of bond riskpremia translates into economic gains for bond investors. We show that aneterm structure models (ATSMs) estimated by jointly tting yields and bond excessreturns capture this predictive information otherwise hidden to standard ATSMestimations. The model's excess return predictions are unbiased, produce regression R2s beyond those reported in the literature, exhibit high forecast accuracy, and allow to generate positive bond portfolio excess returns in- and out-of-sample. Nevertheless, these models cannot beat the expectations hypothesis (EH) out-ofsample: the forecasts do not add economic value compared to using the average historical excess return as an EH-consistent estimate of constant risk premia. We show that in general statistical signicance does not necessarily translate into economic signicance because EH deviations mainly matter at short horizons and standard predictability metrics are not compatible with common measures of economic value. Overall, the EH remains the benchmark for investment decisions and should be considered an economic prior in models of bond risk premia.

    AB - This paper studies whether the evident statistical predictability of bond riskpremia translates into economic gains for bond investors. We show that aneterm structure models (ATSMs) estimated by jointly tting yields and bond excessreturns capture this predictive information otherwise hidden to standard ATSMestimations. The model's excess return predictions are unbiased, produce regression R2s beyond those reported in the literature, exhibit high forecast accuracy, and allow to generate positive bond portfolio excess returns in- and out-of-sample. Nevertheless, these models cannot beat the expectations hypothesis (EH) out-ofsample: the forecasts do not add economic value compared to using the average historical excess return as an EH-consistent estimate of constant risk premia. We show that in general statistical signicance does not necessarily translate into economic signicance because EH deviations mainly matter at short horizons and standard predictability metrics are not compatible with common measures of economic value. Overall, the EH remains the benchmark for investment decisions and should be considered an economic prior in models of bond risk premia.

    KW - Term structure of interest rates

    KW - Expectations hypothesis

    KW - Affine models

    KW - Risk premia

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    Sarno L, Schneider P, Wagner C. The Economic Value of Predicting Bond Risk Premia: Can Anything Beat the Expectations Hypothesis?. 2013. Paper presented at Research Seminar, Innsbruck, Austria. Available from, DOI: 10.2139/ssrn.2005178