Premium
Macroeconomic Sources of Risk in the Term Structure
Author(s) -
BALFOUSSIA HIONA,
WICKENS MIKE
Publication year - 2007
Publication title -
journal of money, credit and banking
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.763
H-Index - 108
eISSN - 1538-4616
pISSN - 0022-2879
DOI - 10.1111/j.0022-2879.2007.00009.x
Subject(s) - econometrics , term (time) , risk premium , economics , yield curve , stochastic discount factor , bond , affine term structure model , multivariate statistics , capital asset pricing model , mathematics , statistics , finance , physics , quantum mechanics
We develop a new way of modeling time variation in term premia, based on the stochastic discount factor model of asset pricing. The joint distribution of excess U.S. bond returns of different maturity and the observable fundamental macroeconomic factors is modeled using multivariate GARCH with conditional covariances in the mean to capture the term premia. By testing the assumption of no arbitrage we derive a specification test of our model. We estimate the contribution made to the term premia at different maturities through real and nominal sources of risk. From the estimated term premia we recover the term structure of interest rates and examine how it varies through time. Finally, we examine whether the reported failures of the rational expectations hypothesis can be attributed to an omitted time‐varying term premium.