Journal Article

A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets

Ravi Bansal and Ivan Shaliastovich

in The Review of Financial Studies

Published on behalf of The Society for Financial Studies

Volume 26, issue 1, pages 1-33
Published in print January 2013 | ISSN: 0893-9454
Published online October 2012 | e-ISSN: 1465-7368 | DOI: https://dx.doi.org/10.1093/rfs/hhs108
A Long-Run Risks Explanation of Predictability Puzzles in Bond and Currency Markets

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  • Money and Interest Rates
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We show that bond risk premia rise with uncertainty about expected inflation and fall with uncertainty about expected growth; the magnitude of return predictability using these uncertainty measures is similar to that by multiple yields. Motivated by this evidence, we develop and estimate a long-run risks model with timevarying volatilities of expected growth and inflation. The model simultaneously accounts for bond return predictability and violations of uncovered interest parity in currency markets. We find that preference for early resolution of uncertainty, time-varying volatilities, and non-neutral effects of inflation on growth are important to account for these aspects of asset markets.

Keywords: E43; F31; G12; G15

Journal Article.  14278 words.  Illustrated.

Subjects: Money and Interest Rates ; International Finance ; Economics ; International Financial Markets

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