Bond Risk Premia: The Information in (Really) Long Term Rates
Subject
Finance
Publishing details
Social Sciences Research Network
Authors / Editors
Berardi A; Brown R; Schaefer S M
Biographies
Publication Year
2021
Abstract
The seminal paper by Fama and Bliss (1987) showed that the slope of the forward curve -- the difference between the forward rates for maturities T and zero -- contains information about the risk premium on the T-maturity bond. In this paper we show that -- adjusted for convexity -- the slope of the forward curve between two long maturities is itself a close approximation to the difference in risk premia and that a "model-free" estimate of the difference in risk premia at long maturities can be obtained directly from data on forward rates and volatility. Successful extraction of this information on risk premia in a term structure model requires both the use of long-term data in estimation and a model that captures the dynamics of volatility. Using a four-factor stochastic volatility model, we find that risk premia are largely determined by volatility and that including data on long-term rates in estimation dramatically improves the precision of estimates of both risk premia and expected short rates.
Series
Social Sciences Research Network