Andrea Berardi and Stephen Schaefer recently finalized a project sponsored by Inquire Europe.
Understanding the extent to which the shape of the yield curve reflects risk premia or investors’ expectations of future rates, is an issue of fundamental importance to both policy makers and investors. We show that the information in long-maturity yields substantially mitigates the problem of separation since, at long maturities, estimates of the slope of the term structure of bond risk premia depend very little on expectations and are “almost observable”.
We apply this approach to European government bonds and derive estimates of the implied term structures of bond risk premia, term premia and short rate expectations. Using information on inflation-linked bonds, we decompose nominal rates into their real and inflation related elements.
For policymakers, our approach represents a new analytical tool. For investment managers, it provides more precise estimates of time-varying bond risk premia and so has the potential to improve portfolio allocation decisions.
You will find the full paper on our website