The authors examine whether forward rates can predict excess bond returns through a common risk premium. They identify a tent shaped forecasting factor tied to the business cycle, with explanatory power reaching 43%, while challenging yield curve models built around level, slope, and curvature.
Bond Risk Premia
Monika Piazzesi, John Cochrane
Research
45 Pages
Key Takeaways
Stronger Return Forecasts: Forward rate regressions explain 34% to 37% of excess bond return variation, more than doubling the roughly 15% achieved by earlier models.
One Dominant Factor: A single tent shaped combination of forward rates captures more than 99% of the variation in expected excess bond returns.
Hidden Yield Information: Traditional level, slope, and curvature factors explain 99.4% of yield changes but collectively provide only 23% explanatory power for expected returns.
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