@techreport{NBERw9178,
title = "Bond Risk Premia",
author = "John H. Cochrane and Monika Piazzesi",
institution = "National Bureau of Economic Research",
type = "Working Paper",
series = "Working Paper Series",
number = "9178",
year = "2002",
month = "September",
doi = {10.3386/w9178},
URL = "http://www.nber.org/papers/w9178",
abstract = {This paper studies time variation in expected excess bond returns. We run regressions of annual excess returns on forward rates. We find that a single factor predicts 1-year excess returns on 1-5 year maturity bonds with an R2 up to 43%. The single factor is a tent-shaped linear function of forward rates. The return forecasting factor has a clear business cycle correlation: Expected returns are high in bad times, and low in good times, and the return-forecasting factor forecasts long-run output growth. The return-forecasting factor also forecasts stock returns, suggesting a common time-varying premium for real interest rate risk. The return forecasting factor is poorly related to level, slope, and curvature movements in bond yields. Therefore, it represents a source of yield curve movement not captured by most term structure models. Though the return-forecasting factor accounts for more than 99% of the time-variation in expected excess bond returns, we find additional, very small factors that forecast equally small differences between long term bond returns, and hence statistically reject a one-factor model for expected returns.},
}