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16
The Structure of Risks in Equilibrium Affine Models of Bond Yields ∗
, 2013
"... Many equilibrium term structure models (ETSMs) in which the state of the economy follows an affine process imply that the variation in expected excess returns on bond portfolio positions is fully spanned by the conditional variances of the state variables. We show that these two assumptions alone – ..."
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Cited by 6 (4 self)
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Many equilibrium term structure models (ETSMs) in which the state of the economy follows an affine process imply that the variation in expected excess returns on bond portfolio positions is fully spanned by the conditional variances of the state variables. We show that these two assumptions alone – an affine state process with conditional variances that span expected excess returns – are sufficient to econometrically identify the factors determining risk premiums in these ETSMs from data on the term structure of bond yields. Using this result we derive maximum likelihood estimates of the conditional variances of the state – the “quantities of risk” – and evaluate the goodnessoffit of a large family of affine ETSMs. These assessments of fit are fully robust to the values of the parameters governing preferences and the evolution of the state, and to whether or not the economy is arbitrage free. Our findings suggest that, to be consistent with U.S. macroeconomic and Treasury yield data, affine ETSMs should have the features that: (i) inflation risk, and not longrun risks or variation in risk premiums arising from habitbased preferences, is a significant (and perhaps the dominant) risk underlying risk premiums in U.S. Treasury markets; and (ii) risks that are unspanned by bond yields have substantial explanatory power for risk premiums consistent with timevarying market prices of risks.
2013, ‘Default, liquidity and crises: an econometric framework
 Journal of Financial Econometrics
"... Preliminary version Abstract: In this paper, extending the work by Gourieroux, Monfort and Polimenis (2006) [78], we present a general discretetime affine framework aimed at jointly modeling yield curves that are associated with different issuers. The underlying fixedincome securities may differ i ..."
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Preliminary version Abstract: In this paper, extending the work by Gourieroux, Monfort and Polimenis (2006) [78], we present a general discretetime affine framework aimed at jointly modeling yield curves that are associated with different issuers. The underlying fixedincome securities may differ in terms of credit quality and/or in terms of liquidity. The risk factors follow discretetime Gaussian processes, with drifts and variancecovariance matrices that are subject to regime shifts described by a Markov chain with (historical) nonhomogenous transition probabilities. While flexible, the model remains tractable and amenable to empirical estimation. This is illustrated by an application on euroarea government yields. Specifically, the common dynamics of ten euroarea government yield curves are estimated using weekly data spanning the period from 1999 to early 2010. The dynamics of the yield curves are satisfyingly explained by both observable factors and unobservable ones. Among the latter, we exhibit a euroareawide liquidityrelated latent factor. The estimation results suggest that an important share of the changes in euroarea yield differentials is liquiditydriven.
Liquidity Risk in Credit Default Swap Markets*
"... We show that liquidity risk is priced in the cross section of returns on credit default swaps (CDSs). Liquidity risk is defined as covariation between CDS returns and a liquidity factor that captures innovations to CDS market liquidity. Marketwide CDS illiquidity is measured by aggregating deviati ..."
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Cited by 2 (0 self)
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We show that liquidity risk is priced in the cross section of returns on credit default swaps (CDSs). Liquidity risk is defined as covariation between CDS returns and a liquidity factor that captures innovations to CDS market liquidity. Marketwide CDS illiquidity is measured by aggregating deviations of credit index levels from their noarbitrage values implied by the index constituents ’ CDS spreads, and the liquidity factor is the return on a diversified portfolio of index arbitrage strategies. Liquidity risk increases CDS spreads and the expected excess returns earned by sellers of credit protection. Our benchmark model implies that liquidity risk accounts for approximately 20 % of CDS spreads, on average.
Basel Committee on Banking Supervision
"... Liquidity stress testing: a survey of theory, empirics and current industry and supervisory practices October 2013This publication is available on the BIS website (www.bis.org). ..."
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Liquidity stress testing: a survey of theory, empirics and current industry and supervisory practices October 2013This publication is available on the BIS website (www.bis.org).
unknown title
, 2013
"... This paper investigates the risk premia of U.S. corporate and Treasury bonds. Using excess return regressions, two risk factors are derived from yield and macroeconomic data: a priced term risk factor and a priced credit risk factor explain half of the variation in oneyear corporate and Treasury ex ..."
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This paper investigates the risk premia of U.S. corporate and Treasury bonds. Using excess return regressions, two risk factors are derived from yield and macroeconomic data: a priced term risk factor and a priced credit risk factor explain half of the variation in oneyear corporate and Treasury excess returns. The information of the term risk factor is not represented by major yield characteristics but is a hidden risk factor whereas the credit risk factor is not hidden. The term risk premium is earned primarily for exposure to inflation and the yield level and the credit risk premium is earned for an exposure to real growth and the credit spread level. The regression results are usefull for the specification of the market prices of risk in affine credit term structure models: The twofactor representation of the risk premium suggests a rank restriction on the market prices of risk and an additional pricing factor to capture the hidden property of term risk.
Federal Reserve Bank of New York Staff Reports Pricing TIPS and Treasuries with Linear Regressions
, 2012
"... This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in this paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New Y ..."
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This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in this paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors. Pricing TIPS and Treasuries with Linear Regressions
that full credit, including © notice, is given to the source. Flights to Safety
, 2013
"... The authors greatly benefited from discussions with seminar participants at Antwerp University, the ..."
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The authors greatly benefited from discussions with seminar participants at Antwerp University, the
PRELIMINARY DRAFT: PLEASE DO NOT CIRCULATE OR QUOTE
, 2010
"... An objective function is a key component of a strategic portfolio management model used to determine optimal allocations of assets and possibly their associated liabilities over some investment horizon. This paper discusses perspectives and investment philosophies for the management of foreign reser ..."
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An objective function is a key component of a strategic portfolio management model used to determine optimal allocations of assets and possibly their associated liabilities over some investment horizon. This paper discusses perspectives and investment philosophies for the management of foreign reserves, and investigates how to translate the three common policy objectives for reserves (liquidity, safety, and return) into objective functions for strategic reserve management. The paper identifies stochastic programming as a practically advantageous modelling framework to capture the objectives of foreign reserves management, and concludes with an illustration of a strategic reserve management model that trades off expected net returns with costs and liquidity issues related to a potential liquidation of a portion of the portfolio. I would like to thank Oumar Dissou, Jesus Sierra Jimenez, Philippe Muller, Miguel Molico, Greg Bauer, Francisco Rivadeneyra, and Zahir Antia from the Bank of Canada and Jerome Kreuser from RisKontrol Group GmbH for valuable ideas and helpful discussions, and the library staff at the Bank of Canada for excellent research assistance. The views expressed in this paper are mine and not necessarily those of the Bank of Canada. I retain any and all responsibility for errors, omissions, and inconsistencies that may appear in this work.
Expecting the Fed
"... After the creation of the Fed, a few distant lags of the short rate help predict future short rate changes even after conditioning on the information in today’s yield curve. We explain this fact with the presence of frictions in short rate expectations formed by the private sector, which we measure ..."
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After the creation of the Fed, a few distant lags of the short rate help predict future short rate changes even after conditioning on the information in today’s yield curve. We explain this fact with the presence of frictions in short rate expectations formed by the private sector, which we measure using surveys. This expectations channel introduces a wedge between the time series dynamics and the cross section of yields, through which monetary policy delivers persistent surprises to the public. While agents ’ forecast errors about monetary policy are ex post predictable with lagged information, people do not make obvious mistakes. Fed staff’s predictions have similar properties, and sophisticated statistical models fail to beat surveys in real time. In the last three decades, forecasters ’ errors about the short rate comove strongly with those about unemployment and less so inflation. Real activity proxies that predict realized bond returns, pick up their ex ante unexpected component that is orthogonal to measures of timevarying risk premia in the yield curve.
CREDIT AND LIQUIDITY RISKS IN EUROAERA SOVEREIGN YIELD CURVES
, 2011
"... Les Documents de travail reflètent les idées personnelles de leurs auteurs et n'expriment pas nécessairement la position de la Banque de France. Ce document est disponible sur le site internet de la Banque de France « www.banquefrance.fr ». Working Papers reflect the opinions of the authors an ..."
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Les Documents de travail reflètent les idées personnelles de leurs auteurs et n'expriment pas nécessairement la position de la Banque de France. Ce document est disponible sur le site internet de la Banque de France « www.banquefrance.fr ». Working Papers reflect the opinions of the authors and do not necessarily express the views of the Banque de France. This document is available on the Banque de France Website “www.banquefrance.fr”.Credit and liquidity risks in euroarea sovereign yield curves ∗