Narrow Results

From the empirical viewpoint, the Expectation Hypothesis Theory (EHT) of the term structure of interest rates has been extensively tested and rejected for US term structure data. Dai and Singleton [6] show that under the settings of Affine term structure models it is possible that one matches both the historical term structure dynamics and capture an important stylized fact that have contradicted the EHT: Time-varying risk premia. In emerging markets, economic conditions tend to be much less stable than in developed markets. For this reason, if risk premia is dynamic in such markets, intuition would suggest that it is more volatile than in developed markets, implying a stronger statistical rejection of the EHT. In this paper, we verify the robustness of Dai and Singleton's results under these more extreme market conditions. We estimate an arbitrage free Affine Gaussian model for the term structure of swaps in the Brazilian market. We propose an extensive empirical analysis which consists on: defining the optimal number of factors to be used in the model, estimating the model, giving interpretation to the state variables in terms of risk factors, and studying the model implied risk premia. In the end, we propose an application for risk management of interest rates futures portfolios.

We look at the economic significance and at the robustness of the new-generation, tent-shaped return-predicting factors in US Treasuries. We find that, in itself, the precise tent shape is neither robust nor important for predictability. However, we explain why the high number of regressors needed to build a tent factor are required for high predictability, and we provide an economic interpretation for the finding.

This work builds on the work by Joslin et al. [(2011) A new perspective on Gaussian dynamic term structure Models, The Review of Financial Studies24, 926–970] on the affine dynamics of portfolios of yields and addresses the unresolved issues of ‘internal consistency’ mentioned in the same paper. It shows the unexpected constraints that have to be satisfied by the $\mathbb{Q}$-measure evolution of the yield curve if the portfolio of yields has to be interpreted as their principal components. This choice of state variables is common in the recent literature and so our findings are intrinsically interesting. However, we show that our results also extend to a wide class of choices for state variables, when these are chosen as linear combinations of yields. We show that these constraints have important financial consequences, which, to our knowledge, have not been appreciated. In particular, this paper highlights some puzzling issues of compatibility between the $\mathbb{Q}$- and $\mathbb{P}$-measure dynamics of Gaussian dynamic term structure models when principal components are chosen as state variables, once the constraints we derive are taken into account.

This paper studies dynamic asset allocations across stocks, Treasury bonds, and corporate bond indices. We employ a new model where liquidity plays an important role in forecasting excess returns. We document the significant utility benefits an investor gains by optimally including corporate bond indices in his portfolio. The benefits are bigger for lower-grade bonds. We also find that investment-grade indices are different from high-yield indices in that different risks are priced in these two asset classes. One important difference is that there exist positive "flight-to-liquidity" premia in investment-grade bonds, but we find no such premia in high-yield bonds. We calculate the portfolio behavior and the utility benefits for three types of investors, the "sophisticated", the "average" and the "lazy" investor. We provide practical portfolio advice on investing throughout the business cycle and we study how the total allocations and hedging demands vary with the business conditions. In addition, utilizing our model, we evaluate the significance of the liquidity variable information for the investor. We find that the liquidity information greatly enhances the investor's portfolio performance. Finally, further support in the optimality of the strategies is provided by calculating their in- and out-of-sample realized returns for the last decade.

Financial asset risk premia are widely agreed to vary over time. This paper decomposes these risk premia into expected excess returns earned in short windows around the times of macroeconomic news announcements (which mostly come out at 8:30am) and the expected excess returns that are earned at other times. Using intradaily data, we find that some, but not all, of the time-varying expected excess returns accrue right around macroeconomic announcements. In forecasting six-month cumulative bond returns, there is more predictability in announcement windows than at other times.

This study tests whether individual foreign exchange (Forex) investors can predict future returns, time the market and generate alpha after transaction costs. Using a sample of 1,231 Forex trading accounts and 72,072 trades, the results show that individual Forex investors can predict future returns up to eight days after trade execution, even after controlling for Volatility. The results of return predictability are significant because they support the idea that linear independence is rejected as well as provide empirical evidence that private information is available in the foreign exchange market.

This chapter describes forwards and futures for electricity currently traded in Europe and other markets. Due to the non-storability of electricity, spot prices are highly dependent on local supply and demand conditions, business activity, and weather conditions. Seasonality is also very strong during the day (peak versus off-peak hours), during the week, and during cold and hot seasons. As a consequence, liquidity is low and the day-to-day volatility is much higher than in financial markets. Electricity futures and forwards may help generators, consumers, and marketers to manage volatility, but they also introduce risks of their own. The vast literature shows the elusive behavior of the so-called risk premia. We evaluate the ex post performance of monthly base load futures contracts on the Italian market in 2008–2013.We propose and test a linear approximation of the risk premium with respect to the time to maturity.