Financial conditions, macroeconomic factors and (un)expected bond excess returns

Bond excess returns can be predicted by macro factors, however, large parts remain still unexplained. We apply a novel term structure model to decompose bond excess returns into expected excess returns (risk premia) and the unexpected part. In order to explore these risk premia and innovations, we complement macro variables by financial condition variables as possible determinants of bond excess returns. We find that the expected part of bond excess returns is driven by macro factors, whereas innovations seem to be mainly influenced by financial conditions, before and after the financial crisis. Thus financial conditions, such as financial stress, deserve attention when analyzing bond excess returns.