Expectations Puzzle, Time-Varying Risk Premia, and Dynamic Models of the Term Structure

Download or read book Expectations Puzzle, Time-Varying Risk Premia, and Dynamic Models of the Term Structure written by Qiang Dai and published by . This book was released on 2001 with total page 32 pages. Available in PDF, EPUB and Kindle. Book excerpt: Though linear projections of returns on the slope of the yield curve have contradicted the implications of the traditional quot;expectations theory,quot; we show that these findings are not puzzling relative to a large class of richer dynamic term structure models. Specifically, we are able to match all of the key empirical findings reported by Fama and Bliss and Campbell and Shiller, among others, within large subclasses of affine and quadratic-Gaussian term structure models. Key to this matching are parameterizations of the market prices of risk that let us separately quot;controlquot; the shape of the mean yield curve and the correlation structure of excess returns with the slope of the yield curve. The risk premiums have a simple form consistent with Fama's findings on the predictability of forward rates, and are shown to also be consistent with interest rate, feedback rules used by a monetary authority in setting monetary policy.