Macro Factors and Volatility of Treasury Bond Returns

Abstract

This paper investigates the impact of macroeconomic variables on the volatility of Treasury bond returns. We extract a real factor and a monetary factor from a large set of macroeconomic series that include both real activities and monetary variables. We find that the two extracted macro factors have a significant impact on the volatility of Treasury bond returns. In particular, we find that the real factor affects the return volatility across all maturities, whereas the monetary factor is significantly related to the volatility of short-term bonds. This finding is robust to finite-sample biases and different forecasting horizons, among other things. The results of an out-of-sample analysis show that the predictive regression model with the real factor has better performance than the AR(1) model. One implication of our findings is that policy makers can use monetary policy to stabilize the fluctuation of short-term bonds (e.g., 1- and 2-year) but need to take real activities into account when stabilizing the variation of medium- and long-term bonds (e.g., 5 years and above).