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Macro-finance VARs and bond risk premia: a caveat

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  • Taboga, Marco
Abstract
Around the turn of the Twentieth century, US and euro area long-term bond yields experienced a remarkable decline and remained at historically low levels even in the face of rising short-term rates (the so called "conundrum"). This unusual phenomenon has been analyzed by many researchers through the lens of macro-finance VARs and no-arbitrage term structure models. A commonly found result is that the decline in long-term rates was primarily driven by an unprecedented reduction in risk premia. I show that such result might be an artefact of the class of models employed to study the phenomenon. I propose an alternative model which suggests that, although risk premia played an important role in reducing bond yields, other two equally important forces were at play, i.e. a decline in the real natural rate of interest and a structural reduction in inflation expectations. I conclude that, after accounting for permanent shifts in the expectations about the future path of short-term rates, the dynamics of risk premia observed after the turn of the century have not been unusual if considered from an historical perspective.

Suggested Citation

  • Taboga, Marco, 2008. "Macro-finance VARs and bond risk premia: a caveat," MPRA Paper 11585, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:11585
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    References listed on IDEAS

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    More about this item

    Keywords

    Bond yields; forward premia; macro-finance models;
    All these keywords.

    JEL classification:

    • E0 - Macroeconomics and Monetary Economics - - General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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