Working Paper: NBER ID: w31787
Authors: Josh Davis; Cristian Fuenzalida; Leon Huetsch; Benjamin Mills; Alan M. Taylor
Abstract: Benchmark finance and macroeconomic models appear to deliver conflicting estimates of the natural rate and bond risk premia. This natural rate puzzle applies not only in the U.S. but across many advanced economies. We use a unified no-arbitrage macro- finance model with two trend factors to estimate the natural rate r* for 10 advanced economies. We cover a longer and wider sample than previous studies and draw on new sources to construct yield curves and excess returns. The two-trend model improves the explanatory power of yield regressions and return forecasts. Most variation in yields is due to the macro trends r* and π*, and not bond risk premia. Global components of unexpected bond returns are influential, while the local components of natural rates are large. Our r* estimates covary with growth and demographic variables in a manner consistent with theory and previous findings.
Keywords: natural rate; bond risk premia; macro finance; advanced economies
JEL Codes: C13; C32; E43; E44; E47; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| natural rate (r) (E43) | bond yields (G12) |
| inflation trends (π) (E31) | bond yields (G12) |
| natural rate (r) (E43) | bond risk premia (rp) (G12) |
| inflation trends (π) (E31) | bond risk premia (rp) (G12) |