Information in the term structure of yield curve volatility

We study information in the volatility of US Treasuries. We propose a no-arbitrage term structure model with a stochastic covariance of risks in the economy, and estimate it using high-frequency data and options. We identify volatilities of the expected short rate and of the term premium. Volatility of short rate expectations rises ahead of recessions and during stress in financial markets, while term premium volatility increases in the aftermath. Volatile short rate expectations predict economic activity independently of the term spread at horizons up to one year, and are related to measures of monetary policy uncertainty. The term premium volatility comoves with a more general level of economic policy uncertainty. We also study channels through which volatility affects model-based inference about the yield curve

Modeling the term structure of interest rates

This doctoral thesis studies the behavior of yields on government bonds. I focus on three aspects of the yield curve: (i) the link between bond yields and key macro quantities such as consumption growth, (ii) the process of expectations formation about the short term interest rate which, in most developed markets, is the main monetary policy instrument, and (iii) the behavior of interest rate volatilities across different maturities. These research questions share a common goal which is to provide guidance for designing macroeconomic models of the yield curve. The economic theory has clear predictions about the joint behavior of macro quantities and the yield curve. However, it has been hard to reconcile these predictions with the observed dynamics of yields. Chapter 1: „Intertemporal Trade-off and the Yield Curve“ empirically evaluates and models the relationship between consumption growth and short term riskless interest rate, charaterized by the elasticity of intertemporal substitution (EIS). Chapter 2: „Expecting the Fed“ studies how investors form their expectations about the short rate. In particular, it evaluates if and how investors expectations deviate from the benchmark of full information rational expectations. Chapter 3 „Information in the term structure of yield curve volatility“ analyzes the dynamic features of yield volatilities and undertakes their modeling. Chapters 2 and 3 are based on joint work with Anna Cieslak

Expected returns in treasury bonds

We decompose Treasury yields into long-horizon inflation expectations and maturity related cycles. Cycles combine the risk premium and the business cycle variation in short rate expectations. From cycles, we construct a measure of expected bond returns. The risk premium factor varies at a frequency higher than the business cycle, and predicts excess bond returns in- and out-of sample. The decomposition captures in a parsimonious way the predictable element of bond returns usually measured with a linear combination of forward rates

Nominal term spread, real rate and consumption growth

We show the negative of the nominal term spread closely tracks the ex-ante real rate. Connecting this result to the well-documented predictability of output and consumption growth by the term spread, we argue that the estimates of the elasticity of intertemporal substitution (EIS) obtained from the aggregate Euler equation are biased in that they imply a negative EIS. This fact provides one explanation for why it is difficult to link empirically the behavior of asset prices to macro aggregates in the standard representative-agent asset pricing and macro models. We show that a general equilibrium model with heterogeneous agents and limited market participation can account for the change in sign of the relationship between the real rate and consumption or output growth

Expecting the fed

We study private sector expectations about the short-term interest rate. We uncover persistent differences between the ex-ante real rate perceived by agents in real-time and its full-sample counterpart estimated by the econometrician. Entering recessions, agents systematically overestimate the real rate, and underestimate future unemployment and the degree of monetary easing. These forecast errors induce persistence in identified monetary policy shocks and cause the econometrician to overstate the variation in Treasury risk premia. Our evidence offers a new interpretation of the unspanned factors phenomenon in the yield curve, emphasizing the key role of information rigidities for the dynamics of real interest rates

Expected returns in Treasury Bonds

We study risk premium in U.S. Treasury bonds. We decompose Treasury yields into inflation expectations and maturity-specific interest-rate cycles, which we define as variation in yields orthogonal to expected inflation. The short-maturity cycle captures the real short-rate dynamics. Jointly with expected inflation, it comprises the expectations hypothesis (EH) term in the yield curve. Controlling for the EH term, we extract a measure of risk-premium variation from yields. The risk-premium factor forecasts excess bond returns in and out of sample and subsumes the common bond return predictor obtained as a linear combination of forward rates

Information in the Term Structure of Yield Curve Volatility

Using a novel no-arbitrage model and extensive second-moment data, we decompose conditional volatility of U.S. Treasury yields into volatilities of short-rate expectations and term premia. Short-rate expectations become more volatile than premia before recessions and during asset market distress. Correlation between shocks to premia and shocks to short-rate expectations is close to zero on average and varies with the monetary policy stance. While Treasuries are nearly unexposed to variance shocks, investors pay a premium for hedging variance risk with derivatives. We illustrate the dynamics of the yield volatility components during and after the financial crisis

Information in the term structure of yield curve volatility

We study volatility of US Treasuries. We propose a term structure model with stochastically correlated risks, which we estimate using realized volatilities and options. We identify time-varying volatilities and comovement of short-rate expectations and term premia. Volatility of short-rate expectations rises before recessions, predicts economic activity beyond the term spread, and covaries with measures of monetary policy uncertainty. Term premia become increasingly volatile in the aftermath of recessions and when economic policy uncertainty is high. Their correlation with expected short-rates fluctuates over time but is positive on average. Within an affine model, volatility has a small effect on the first moments of yields