Explaining Bond Return Predictability in an Estimated New Keynesian Model

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Abstract

This paper estimates a New Keynesian model that explains key macro series, the ten-year nominal yield curve, and the ability of the spread between long- and short-term bond yields to predict future excess bond returns. The model also generates an upward sloping nominal and real yield curve, produces a positive inflation risk premium, and recovers the prediction by the expectations hypothesis of no return predictability when historical bond yields are risk-adjusted using term premia from the proposed model. Key to obtaining these results is a new specification of stochastic volatility that allows high current inflation to generate high future uncertainty.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages57
Publication statusPublished - 23 May 2019
SeriesCREATES Research Paper
Number2019-11

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