Regime Shifts and Bond Returns
November 1, 1999
Jacob Boudoukh, Matthew Richardson, Tom Smith, Robert Whitelaw
ABSTRACT
This paper investigates the implications of a 2-regime model of the business cycle for term premiums and volatilities
in the bond market. The model, which is estimated via maximum likelihood using GDP, consumption and production
data, has two key features -- mean growth rates that vary across regimes and time-varying transition probabilities
between regimes. The implied dynamics of term premiums and volatilities are complex and interesting. Business cycle
turning points are characterized by high volatility and strongly time-varying term premiums. These implications
are then investigated using data on bond returns. Nonparametric estimation results are broadly consistent with
the model. Using the slope of the term structure as a conditioning variable, we can identify periods with negative
term premiums and volatile returns.
Subject: Investments/Fixed Income, Investments/Predictability of Asset Returns, Investments/Volatility of Asset Prices
Classification: Empirical, Theoretical
Boudoukh: (212) 998-0305 jboudouk@stern.nyu.edu
http://www.stern.nyu.edu/~jboudouk/
Richardson: (212) 998-0349 mrichar0@stern.nyu.edu
http://www.stern.nyu.edu/~mrichar0/
Smith:
Australian Graduate School of Management, University of New South Wales
Whitelaw (212) 998-0338 rwhitela@stern.nyu.edu
http://www.stern.nyu.edu/~rwhitela/
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