The maturity structure of term premia with time-varying expected returns

This paper analyzes the maturity structure of term premia using McCulloch’s US Treasury yield curve data from 1953–91, allowing expected returns to vary across time. One, 3, 6, and 12 month holding period returns on maturities up to 5 years are projected on 3 ex ante variables to compute time-varying expected returns, and simulations are employed to generate distributions of conditionally expected return premia. The likelihood of expected returns monotonically increasing in maturity (as implied by the liquidity preference hypothesis) is relatively high when the yield curve is steep and interest rates are high, and with longer holding periods, but low in other cases. The hypothesis that intermediate maturity bonds have the highest expected returns (a “hump-shaped” maturity-return pattern) around the onset of recessions does not receive much support.