Macro Risks and the Term Structure of Interest Rates∗ Geert Bekaert, Columbia University and the National Bureau of Economic Research, Eric Engstrom, Board of Governors of the Federal Reserve System Andrey Ermolov, Gabelli School of Business, Fordham University May 31, 2018 Abstract We use non-Gaussian features in U.S. macroeconomic data to identify aggregate supply and demand shocks while imposing minimal economic assumptions. Recessions in the 1970s and 1980s were driven primarily by supply shocks; later recessions by demand shocks. We estimate macro risk factors that drive \bad" (negatively skewed) and \good" (positively skewed) variation for supply and demand shocks. We document that macro risks significantly contribute to the variation of yields, risk premiums and return variances for nominal bonds. While overall bond risk premiums are counter-cyclical, an increase in aggregate demand variance significantly lowers risk premiums. Keywords: macroeconomic volatility, business cycles, bond return predictability, term premium, Great Moderation JEL codes: E31, E32, E43, E44, G12, G13 ∗Contact information: Geert Bekaert -
[email protected], Eric Engstrom - eric.c.
[email protected], Andrey Ermolov -
[email protected]. Authors thank Michael Bauer, Mikhail Chernov, Philipp Illeditsch, Andrea Vedolin, seminar participants at Baruch College, Bilkent University, University of British Columbia, Bundesbank, City University of London, Duke, Fordham, University of Illinois at Urbana-Champaign, Imperial College, Oxford, Riksbank, Sabanci Business School, Tulane, University of North Carolina at Chapel-Hill, and Stevens Institute of Technology and conference par- ticipants at 2015 Federal Reserve Bank of San Francisco and Bank of Canada Conference on Fixed Income Markets, 2016 NBER Summer Institute, 2016 Society of Financial Econometrics Meeting, 2017 European Finance Association Meeting, 2017 NBER-NSF Time Series Conference, Spring 2018 Midwest Macroeconomics Meetings, and 2018 SFS Cavalcade North America for useful comments.