Abstract
Considering the Chinese and U.S. bond risk premia jointly, we find that n-year bond excess return can be forecast by n-year forward rate, rather than forward spread, during 03/2006-12/2016 with R^2s up to 51% and 48%, which means that expectations hypothesis fails in these two markets. Based on a seminal one-factor model introduced by Cochrane and Piazzesi (2005), we develop a two-factor model forecasting excess returns with R^2 up to 63%. The two-factor model outperforms the one-factor model, measured by Generalized Method of Moments and Wald tests. An affine model shows that the state variables dynamics and risk attitude structures in the U.S. bond market change radically in last decade.
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