Zero-Coupon Yields and the Cross-Section of Bond Prices

Abstract

I estimate a dynamic term-structure model with time-varying risk premia on a panel of Treasury coupon bonds, without relying on an interpolated zero-coupon yield curve or a selection of maturities. The model implies that coupon-bond prices are linear functions of latent factors. I use the model to quantify the large deviations between the prices of bonds older and younger than 15 years during the financial crisis. I show that prices of risk estimated from short-horizon vector autoregressions of latent factors lead to biased forecasts of long-horizon holding-period returns; prices of risk estimated on realized holding-period returns lead to better forecasts.