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Trolle Discussion Jurek
Trolle Discussion Jurek
Trolle Discussion Jurek
Jakub W. Jurek
May 2011
Big Picture
The dynamics of real rates and inflation can interact in meaningful ways to determine
the “riskiness” of nominal securities: inflationary vs. deflationary recessions.
I Time-varying covariance of bond/stock returns (Viceira (2010)) → equilibrium
risk premia change sign.
I Important implications for pension plan liability management.
Big Picture
Time-varying bond beta
This Paper
The contribution of this paper is to study to the dynamics of nominal interest rates
using a comprehensive swaption dataset:
1. Model-free moments
2. Unspanned stochastic volatility + skewness
3. Proposes and estimates and affine term structure model with stochastic skewness
4. Moments and risk premia linked to survey measures of real growth rates and
inflation expectations
Data
A European swaption gives the owner the right to enter into a fixed versus floating
forward starting interest rate swap at a predetermined rate on the fixed leg.
1. Swaption cube:
I maturity of underlying interest rates swap (2, 5, 10, 20, 30 years)
I option tenor (1, 3, 6, 9 months, 1, 2, 5, 10 years)
I strikes (up to 15 values)
2. Date range: Jun./Dec. 2001 – Jan. 2010
3. Cross section: USD + EUR
4. Source: ICAP
Data
Implementation
are combined with “standard” affine or extended affine specification of bond and
volatility risk premia (Duffie and Kan (1996), Cheridito, Filipovic and Kimmel (2007))
Estimation disclaimers:
I Parameter values for bond risk premia unreported → estimation is known to
occasionally produce implausibly large implied Sharpe ratios.
I Standard errors based on outer-product estimator of covariance matrix. Hessian is
“somewhat numerically unstable.”
Model
I The first (second) volatility factor induces negative (positive) skewness in bond
returns → inflation (deflation) fear factors.
Results
Inflation/deflation fears
I The first (second) volatility factor induces negative (positive) skewness in bond
returns → inflation (deflation) fear factors.
I Variation in the magnitudes of the two volatility factors should help reconcile
pricing of inflation-indexed and nominal bonds.
I Do model-implied quantities help forecast bond excess returns?
I Contribution of real rate risk premia and inflation risk premia to explaining violations of
the expectations hypothesis in US + UK data.
Results
Inflation/deflation fears
I The first (second) volatility factor induces negative (positive) skewness in bond
returns → inflation (deflation) fear factors.
I Variation in the magnitudes of the two volatility factors should help reconcile
pricing of inflation-indexed and nominal bonds.
I Do model-implied quantities help forecast bond excess returns?
I Contribution of real rate risk premia and inflation risk premia to explaining violations of
the expectations hypothesis in US + UK data.
I Authors push for a model that replicates the unspanned stochastic skewness
features identified in the model-free analysis, but ...
I Feature does not survive in unrestricted estimation → is the minimal set of necessary
restrictions rejected?
I What is the economic magnitude of the skewness risk premium?
Results
Variance and skewness
I Authors push for a model that replicates the unspanned stochastic skewness
features identified in the model-free analysis, but ...
I Feature does not survive in unrestricted estimation → is the minimal set of necessary
restrictions rejected?
I What is the economic magnitude of the skewness risk premium?
I Dynamics of variance and skewness – and the associated risk premia – are linked
to investor uncertainty about economic fundamentals.
I Real GDP growth (inflation) uncertainty is key in determining USD (EUR) swap rate
distributions.
I Is there evidence for shifts in the relative importance of the two channels as a function
of magnitude of each factor’s deviation from its “equilibrium” value?