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Empirical Economics

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01-02-2019

Investigating the expectation hypothesis and the risk premium dynamics: new evidence for Brazil

Author: João F. Caldeira

Published in: Empirical Economics | Issue 1/2020

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Abstract

We re-examine the validity of the expectation hypothesis (EH) of the term structure for the Brazilian fixed income market, using data from January 2000 to June 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 forecasting bond excess returns relative to yield curve information.

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The data for the \({\text {LN}}_t\) factor are obtained from the Brazilian Central Bank, the FGV, the IBGE, the IPEADATA, and the Bloomberg database. The data broadly cover almost all economic categories used in Ludvigson and Ng (2009). In particular, the series includes output and labor market variables, exchange rates, price indexes, income series, and the money stock. Additional details about this data set are given in “Appendix.”

Additional details about this data set and the DI-futuro contract can be found in Caldeira et al. (2016).

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Title: Investigating the expectation hypothesis and the risk premium dynamics: new evidence for Brazil
Author: João F. Caldeira
Publication date: 01-02-2019
Publisher: Springer Berlin Heidelberg
Published in: Empirical Economics / Issue 1/2020
Print ISSN: 0377-7332
Electronic ISSN: 1435-8921
DOI: https://doi.org/10.1007/s00181-019-01629-0

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