Investigating the Expectation Hypothesis and the Risk Premium Dynamics: New Evidence for Brazil

22 Pages Posted: 29 Jan 2019

See all articles by João Caldeira

João Caldeira

Universidade Federal de Santa Catarina & CNPq

Date Written: February 21, 2018

Abstract

We re-examine the validity of the Expectation Hypothesis (EH) of the term structure for the Brazilian fixed income market, using data from Jan-2000 to Jun-2017. Furthermore, we investigated the out-of-sample predictability of bond excess returns by means of common factors extracted from a cross-section of Brazilian macro-variables and zero-coupon interest rates. The EH is rejected throughout the term structure examined on the basis of the statistical tests across the entire maturity spectrum considered. Our results confirm previous findings, mostly obtained for developed markets, that a linear combination of forward rates and macroeconomic factors can explain a substantial portion of movements in bonds excess returns, contributing novel and up- to-date evidence from a large and dynamic emerging bond market, such as Brazil. Furthermore, we find that the factor extracted from a large panel of macroeconomic variables generates significant gains in fore- casting bond excess returns relative to yield curve information.

Keywords: Expectation Hypothesis, Bond Risk Premia, Factor Models, Excess Return Predictability, Out-of-Sample Forecasts

JEL Classification: C53, E43, G17

Suggested Citation

Caldeira, João, Investigating the Expectation Hypothesis and the Risk Premium Dynamics: New Evidence for Brazil (February 21, 2018). Available at SSRN: https://ssrn.com/abstract=3317047 or http://dx.doi.org/10.2139/ssrn.3317047

João Caldeira (Contact Author)

Universidade Federal de Santa Catarina & CNPq ( email )

R. Eng. Agronômico Andrei Cristian Ferreira, s/n
Florianópolis, SC Rio Grande do Sul 90480-004
Brazil

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