Aggregate Liquidity, Macro Factors, and Bond Risk Premia

Abstract

This paper studies time varying bond returns via macroeconomic variables, focusing on changes in the liquidity provisions of banks. We find that the changes in loans and investments by commercial banks and demand deposits can predict annual excess bond returns of different maturities significantly both in-sample and out-of-sample. Further analyses reveal that these variables as wells as other key macro variables not only help explain the role of long-maturity forward rates in terms of bond risk premia, but also show better performance in predicting bond returns.