The Banking View of Bond Risk Premia
Banks' balance-sheet exposure to fluctuations in interest rates strongly forecasts excess Treasury bond returns. This result is consistent with optimal risk management, a banking counterpart to the household Euler equation. In equilibrium, the bond risk premium compensates banks for bearing fluctuations in interest rates. When banks' exposure to interest rate risk increases, the price of this risk simultaneously rises. We present a collection of empirical observations supporting this view, but also discuss several challenges to this interpretation.
We gratefully acknowledge the useful comments and suggestions of Stefan Nagel, an Associate Editor, two anonymous referees, Tobias Adrian, Mikhail Chernov, Anna Cieslak, John Cochrane, Arvind Krishnamurthy, Augustin Landier, Giorgia Piacentino, Monika Piazzesi, David Thesmar, Dimitri Vayanos as well as seminar participants at Kellogg, Princeton, the University of Michigan, Stanford, the Federal Reserve Bank of New York, the UNC Junior Faculty Roundtable, the NBER Summer Institute, CITE, the MFS meeting, the Adam Smith Conference, and the SED Annual Meeting. We have no relevant or material financial interests that relate to the research described in this paper. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
VALENTIN HADDAD & DAVID SRAER, 2020. "The Banking View of Bond Risk Premia," The Journal of Finance, vol 75(5), pages 2465-2502.