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Bond Risk Premia, Priced Regime Shifts, and Macroeconomic Fundamentals

Author

Listed:
  • Constantino Hevia

    (Universidad Torcuato Di Tella)

  • Ivan Petrella

    (Warwick Business School and CEPR)

  • Martin Sola

    (Universidad Torcuato Di Tella)

Abstract

In this paper, we develop and estimate an arbitrage-free model of bond prices in which the evolution of the risk factors and the parameters of the stochastic discountfactor are subject to occasional discrete changes in regimes. We show that the component of risk premia associated with regime shifts is related to the macroeconomic environment. In particular, the explicit pricing of regime shifts and the nonlinearities associated with the Markov switching model generates a strong connection betweenbond risk premia and the macroeconomy as summarized by variables such as inflation, industrial production, and unemployment.

Suggested Citation

  • Constantino Hevia & Ivan Petrella & Martin Sola, 2022. "Bond Risk Premia, Priced Regime Shifts, and Macroeconomic Fundamentals," Working Papers 200, Red Nacional de Investigadores en Economía (RedNIE).
    • Handle: RePEc:aoz:wpaper:200
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    More about this item

    Keywords

    Yield Curve; Term structure of interest rates; Markov regime switching; Priced switching risk prem;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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