Finance Seminar: Anh Le

Joint CORE-FIN seminar

The Structure of Risks in Equilibrium Affine Models of Bond Yields

Anh Le, Penn State

Equilibrium affine term structure models (ETSMs) typically imply that expected excess returns on bonds are determined entirely as an affine function of the conditional variances of the state process. We show that, knowing only this structure of risk premiums, maximum likelihood estimates of these variances can be extracted from the term structure of bond yields. Consistent with ETSMs, the information in US Treasury yields about bond excess returns is spanned by our fitted time-varying volatilities. However, contrary to the structure of ETSMs, there is substantial variation in risk premiums that is unspanned by bond yields owing to a time-varying market price of inflation risk and liquidity or flight-to-quality risks in the Treasury market.
(joint with K. Singleton)