Is the Term Premium a Risk Premium?

• Main Authors: Ederington, Louis H., GOH, Jeremy C.
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 1999
• Subjects: Securities; risk; Business; Corporate Finance; Finance and Financial Management
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/2202; https://ink.library.smu.edu.sg/context/lkcsb_research/article/3201/viewcontent/Term_Premium_1999_pv.pdf
• Institution: Singapore Management University

This paper explores whether excess holding period returns on long vis-a-vis short-term securities behave in a manner that is consistent with (1) market efficiency, (2) the time-varying-term-premium variant of the expectations hypothesis, and (3) theories of the term premium that view it as a reward for risk bearing. Both traditional and modern theories of the term premium imply that it should evolve fairly slowly over time as attitudes toward risk and/or perceived covariances with wealth or consumption change. This implies that this period's term premium should have some predictive ability for next period's. However, we find that this quarter's ex-post term premium has zero predictive ability. For monthly rates and returns, the evidence is less clear cut, but again the implied term premia do not behave in a manner consistent with existing theories.