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Canonical Term-Structure Models with Observable Factors and the Dynamics of Bond Risk Premiums

We study the dynamics of risk premiums on the German bond market, employing no-arbitrage term-structure models with both observable and unobservable state variables, recently popularized by Ang and Piazzesi (2003). We conduct a specification analysis based on a new canonical representation for this class of models. We find that risk premiums display a considerable variability over time, are strongly counter-cyclical and bear no significant relation to inflation.

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Canonical Term-Structure Models with Observable Factors and the Dynamics of Bond Risk Premiums