Working Paper: CEPR ID: DP2392
Authors: Dennis Bams; Christian C.P. Wolff
Abstract: This paper proposes a panel data approach to modeling the risk premium in the term structure of interest rates. Specifically, we develop a fixed maturity/random time effects model that implies a time-invariant one-factor model. Our approach allows us to disentangle risk premia and unexpected excess returns, which is not possible in the standard time series approach. In addition, small sample bias is alleviated and statistical efficiency improved. Our results allow for interesting inferences about maturity-specific effects in the term structure. First, the expectations hypothesis is soundly rejected for our full data panel of U.S. Treasury securities. Second, a considerable degree of mean reversion is present in the risk premia. Third, our findings shed new light on the magnitude of the slope coefficient in regressions of the yield onto the forward curve.
Keywords: expectations hypothesis; risk premium
JEL Codes: E43; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expectations hypothesis (D84) | risk premia (G22) |
| forward rates (E43) | future yields (G12) |
| risk premia (G22) | term structure variations (E43) |
| risk premia (G22) | mean reversion (C22) |
| maturity (D25) | risk premia (G22) |
| slope coefficient (C29) | expectations hypothesis (D84) |