Publication Type
Journal Article
Version
publishedVersion
Publication Date
11-2022
Abstract
We find that interest rate variance risk premium (IRVRP) — the difference between implied and realized variances of interest rates — is a strong predictor of U.S. Treasury bond returns of maturities ranging between one and ten years for return horizons up to six months. IRVRP is not subsumed by other predictors such as forward rate spread or equity variance risk premium. These results are robust in a number of dimensions. We rationalize our findings within a consumption-based model with long-run risk, economic uncertainty, and inflation non-neutrality. In the model IRVRP is related to short-run risk only, while standard forward-rate-based factors are associated with both short-run and long-run risks in the economy. Our model qualitatively replicates the predictability pattern of IRVRP for bond returns.
Keywords
bond return predictability, economic uncertainty, interest rate derivatives, interest rate variance risk premium, long-run risk, term structure of interest rates
Discipline
Finance
Research Areas
Finance
Areas of Excellence
Growth in Asia
Publication
Journal of Finance and Data Science
Volume
8
First Page
255
Last Page
295
ISSN
2405-9188
Identifier
10.1016/j.jfds.2022.09.001
Publisher
KeAi
Citation
GRISHCHENKO, Olesya V.; SONG, Zhaogang; and ZHOU, Hao.
Term structure of interest rates with short-run and long-run risks. (2022). Journal of Finance and Data Science. 8, 255-295.
Available at: https://ink.library.smu.edu.sg/lkcsb_research/7928
Creative Commons License
This work is licensed under a Creative Commons Attribution-NonCommercial-No Derivative Works 4.0 International License.
External URL
https://api.elsevier.com/content/abstract/scopus_id/85141290840
Additional URL
https://doi.org/10.1016/j.jfds.2022.09.001