Macro Factors in Bond Risk Premia

Posted: 24 Nov 2009

See all articles by Sydney C. Ludvigson

Sydney C. Ludvigson

New York University - Department of Economics; National Bureau of Economic Research (NBER)

Serena Ng

Columbia University - Columbia Business School, Economics

Multiple version iconThere are 2 versions of this paper

Date Written: December 2009

Abstract

Are there important cyclical fluctuations in bond market premiums and, if so, with what macroeconomic aggregates do these premiums vary? We use the methodology of dynamic factor analysis for large datasets to investigate possible empirical linkages between forecastable variation in excess bond returns and macroeconomic fundamentals. We find that “real” and “inflation” factors have important forecasting power for future excess returns on U.S. government bonds, above and beyond the predictive power contained in forward rates and yield spreads. This behavior is ruled out by commonly employed affine term structure models where the forecastability of bond returns and bond yields is completely summarized by the cross-section of yields or forward rates. An important implication of these findings is that the cyclical behavior of estimated risk premia in both returns and long-term yields depends importantly on whether the information in macroeconomic factors is included in forecasts of excess bond returns. Without the macro factors, risk premia appear virtually acyclical, whereas with the estimated factors risk premia have a marked countercyclical component, consistent with theories that imply investors must be compensated for risks associated with macroeconomic activity.

Keywords: E0, E4, G10, G12

Suggested Citation

Ludvigson, Sydney C. and Ng, Serena, Macro Factors in Bond Risk Premia (December 2009). The Review of Financial Studies, Vol. 22, Issue 12, pp. 5027-5067, 2009, Available at SSRN: https://ssrn.com/abstract=1509902 or http://dx.doi.org/hhp081

Sydney C. Ludvigson (Contact Author)

New York University - Department of Economics ( email )

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Serena Ng

Columbia University - Columbia Business School, Economics ( email )

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