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An asset pricing approach to testing general term structure models

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We develop a new empirical approach to term structure analysis that allows testing for time-varying risk premiums and arbitrage opportunities in models with both unobservable factors and factors identied as the innovations to observed macroeconomic variables. Factors may play double roles as both covariance-generating common shocks driving yields and determinants of market prices of risk in cross-sectional pricing. The evidence favors time-varying risk prices signicantly related to the second Stock-Watson principal component of macroeconomic variables and to changes in the
industrial production index. Our preferred specication includes these two observable and two unobservable factors, with the no-arbitrage condition imposed.
Original languageEnglish
JournalJournal of Financial Economics
Pages (from-to)165-191
Number of pages27
Publication statusPublished - 2019

    Research areas

  • Bond aging effect, Macroeconomic conditioning variables, Nonlinear drift restriction, Time-varying risk premiums, Yield curve model

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