Working Paper: NBER ID: w16892
Authors: Carolin E. Pflueger; Luis M. Viceira
Abstract: Estimating the liquidity differential between inflation-indexed and nominal bond yields, we separately test for time-varying real rate risk premia, inflation risk premia, and liquidity premia in U.S. and U.K. bond markets. We find strong, model independent evidence that real rate risk premia and inflation risk premia contribute to nominal bond excess return predictability to quantitatively similar degrees. The estimated liquidity premium between U.S. inflation-indexed and nominal yields is systematic, ranges from 30 bps in 2005 to over 150 bps during 2008-2009, and contributes to return predictability in inflation-indexed bonds. We find no evidence that bond supply shocks generate return predictability.
Keywords: Treasury market; Return predictability; Inflation; Liquidity; Bond yields
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity risk (G33) | bond return predictability (G12) |
| liquidity premium (E41) | predictability of nominal bond excess returns (G12) |
| real rate risk premia (E43) | predictability of nominal bond excess returns (G12) |
| inflation risk premia (E31) | predictability of nominal bond excess returns (G12) |
| liquidity-adjusted bond returns (G12) | nominal term spread (E43) |
| time-varying liquidity risk (E44) | predictability in inflation-indexed bond excess returns (G12) |