Yield Curve Premia

Abstract

We examine return premia associated with the level, slope, and curvature of the yield curve over time and across countries from a novel perspective by borrowing pricing factors from other asset classes. Measures of value, momentum, and carry, when applied to bonds, provide a rich description of bond return premia: subsuming pricing information from the yield curve’s first three principal components, as well as priced factors unspanned by yield information, such as macroeconomic growth, inflation, and the Cochrane and Piazzesi (2005) factor. These characteristics provide new economic intuition for what drives bond return premia, where value, measured by a bond’s yield relative to a fundamental anchor of expected inflation, subsumes a “level” factor. Momentum, which reveals recent yield trends, and carry, which captures expected future yields if the yield curve does not change, subsume information about expected returns from the slope and curvature of the yield curve. These characteristics describe both the cross-section and time-series of yield curve premia and connect to return predictability in other asset classes, suggesting a unifying asset pricing framework.

Keywords: fixed income, asset pricing, international financial markets

JEL Classification: G12, G15