Working Paper: CEPR ID: DP18592
Authors: Junye Li; Lucio Sarno; Gabriele Zinna
Abstract: We analyze the risk-return trade-off in the US Treasury market using a term structure model that features volatility-in-mean effects of multiple sources, and yet preserves tractable bond prices. We find a strong positive relation between risks and risk premia over the 1966-2018 period. While interest-rate risk is the main driver of such positive relation, macro risk plays a non-trivial role, and its omission leads to unstable estimates of the trade-off. Notably, macro risk contributes to the surge and consequent fall of risk premia around the 1980s, whereas it moves inversely with risk premia during the recent 'low yield' period.
Keywords: Treasury market; risk-return tradeoff; term structure models; bond risk premium; macro risk
JEL Codes: C58; E43; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risks (D81) | risk premia (G22) |
| interest-rate risk (E43) | risk premia (G22) |
| macro risks (E66) | risk premia (G22) |
| level factor risk (G41) | risk premia (G22) |
| macro risks (E66) | slope factor risk (G17) |
| shocks to level risk (D81) | risk premia (G22) |
| shocks to slope risk (G17) | risk premia (G22) |
| shocks to non-farm payroll growth (nfpyr) (J49) | risk premia (G22) |