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An empirical analysis of unspanned risk for the U.S. yield curve

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  • Karoll Gomez

    (Universidad Nacional de Colombia)

Abstract

In this paper, I formally test for the unspanning properties of liquidity premium risk in the context of a joint Gaussian affine term structure model for zero-coupon U.S. Treasury and TIPS bonds. In the model, the liquidity factor is regarded as an additional factor that does not span the yield curve, but improves the forecast of bond risk premia. I present empirical evidence suggesting that liquidity premium indeed helps to forecast U.S. bond risk premia in spite of not being linearly spanned by the information in the joint yield curve. In addition, I show that the liquidity factor does not affect the dynamics of bonds under the pricing measure, but does affect them under the historical measure. Further, variation in the TIPS liquidity premium predicts the future evolution of the traditional yield curve factors

Suggested Citation

  • Karoll Gomez, 2016. "An empirical analysis of unspanned risk for the U.S. yield curve," Lecturas de Economía, Universidad de Antioquia, Departamento de Economía, issue 85, pages 11-51, Julio - D.
    • Handle: RePEc:lde:journl:y:2016:i:85:p:11-51
    DOI: 10.17533/udea.le.n85a01
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    More about this item

    Keywords

    liquidity risk; inflation-indexed bond market; affine term structure; unspanned factors; predictability;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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