Time-varying Bond Risk Premia

Before 2005,it was considered that the expectation hypothesis succeeded in Chinese bond market,and there was no risk premia between the long-term and short-term bonds.Since the the real investor preference obeys risk neutral,which expectation hypothesis assumes,the risk premia should exist in the bond market.To investigate this,this work pays attention to the holding period return of default-free zero-coupon bond and try to capture the time-varying feature of the risk premia.This work constructs two kinds of forecasting factors including the level-based factor and slope-based factor,using the feature of forward rates in China.The two-factor model can predict bond risk premia well,and shows the risk premia trend accorss the maturities.All the empirical studies are based on GMM.The sample data from 2006 to 2015 covers financial crisis episode and Monetary tightening period.Furthermore,this work exams the economic information hidden behind the return-forecasting factors by introducing some proxy variables of macroeconomy.To check the robustness of main outcomes,this work tests the small sample issus,multicollinearity issue,out-of-sample and sub-sample performance,as well as measurement error problem.The results show that the expectation hypothesis fails in China,which means the risk premia exist and obviously increase in maturities.In addition,we find the level-based factor holds substantial latent information of macroeconomy which effects the risk premia,and captures the the largest component of risk premia.By contrast,due to the orthogonality between the two factor,the slope does not include the macroeconomy information.But it can improve the forecast performance by capture the second largest component—slope component—of the risk premia.Capturing bond risk premia more precisely can not only help to make right trading decision for investors,but also help to build a more accurate term structure of Chinese bond market.A appropriate term structure will guide the Chinese government to make a correct monetary policy,in order to promote the bond market development as well as improve the bond market structure in China.