Working Paper: NBER ID: w18357
Authors: Ravi Bansal; Ivan Shaliastovich
Abstract: We show that bond risk-premia rise with uncertainty about expected inflation and fall with uncertainty about expected growth; the magnitude of return predictability using these two uncertainty measures is similar to that by multiple yields. Motivated by this evidence, we develop and estimate a long-run risks model with time-varying volatilities of expected growth and inflation. The model simultaneously accounts for bond return predictability and violations of uncovered interest parity in currency markets. We find that preference for early resolution of uncertainty, time-varying volatilities, and non-neutral effects of inflation on growth are important to account for these aspects of asset markets.
Keywords: bond markets; currency markets; predictability; risk premia; inflation uncertainty; growth uncertainty
JEL Codes: E0; F0; F3; G0; G1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inflation uncertainty (E31) | bond risk premia (G12) |
| real growth uncertainty (O49) | bond risk premia (G12) |
| volatilities of expected growth (O49) | bond risk premia (G12) |
| volatilities of expected inflation (E31) | bond risk premia (G12) |
| bond risk premia (G12) | predictability of bond returns (G12) |