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Mind the (Convergence) Gap: Bond Predictability Strikes Back!

Author

Listed:
  • Andrea Berardi

    (Department of Economics, Università Ca’ Foscari Venezia, Venezia 30121, Italy)

  • Michael Markovich

    (Quantitative Investment Office, Zurich 8802, Switzerland)

  • Alberto Plazzi

    (Institute of Finance, Università della Svizzera italiana and Swiss Finance Institute, Lugano 6900, Switzerland)

  • Andrea Tamoni

    (Department of Finance, Rutgers Business School, Newark, New Jersey 07102)

Abstract
We show that the difference between the natural rate of interest and the current level of monetary policy stance, which we label Convergence Gap (CG), contains information that is valuable for bond predictability. Adding CG in forecasting regressions of bond excess returns significantly raises the R 2 , and restores countercyclical variation in bond risk premia that is otherwise missed by forward rates. Consistent with the argument that CG captures the effect of real imbalances on the path of rates, our factor has predictive ability for real bond excess returns. The importance of the gap remains robust out-of-sample and in countries other than the United States. Furthermore, its inclusion brings significant economic gains in the context of dynamic conditional asset allocation.

Suggested Citation

  • Andrea Berardi & Michael Markovich & Alberto Plazzi & Andrea Tamoni, 2021. "Mind the (Convergence) Gap: Bond Predictability Strikes Back!," Management Science, INFORMS, vol. 67(12), pages 7888-7911, December.
    • Handle: RePEc:inm:ormnsc:v:67:y:2021:i:12:p:7888-7911
    DOI: 10.1287/mnsc.2020.3847
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