Premium
Economic Policy Uncertainty and Bond Risk Premia
Author(s) -
IOANNIDIS CHRISTOS,
KA KOOK
Publication year - 2021
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/jmcb.12748
Subject(s) - risk premium , economics , bond , affine term structure model , investment (military) , term (time) , government bond , econometrics , bond valuation , yield curve , financial economics , monetary economics , finance , physics , quantum mechanics , politics , political science , law
Abstract We study the forecasting power of economic uncertainty about government policy for future bond returns. Using the economic policy uncertainty measure ( E P U ) developed by Baker, Bloom, and Davis (2016), we investigate its relationship to expected bond returns. The impact of the E P U is shown to be large for earlier maturities at shorter investment horizons. Estimating an affine term structure model incorporating the E P U , we show that term premia estimates from this model with this additional pricing factor exhibit higher fluctuations and move closely with the variations in observed yields. The implied term premia show strong countercyclical movements, hence better explaining higher risk compensation under adverse economic conditions as expected by theory.