Risk Premia and Time Varying Risk. Evidence From the US Bond Markets

In this article, we analyze risk premia and time varying risk of US closed-end bond funds markets. Pessimism or optimism may drive prices far-away from their fundamental. An arbitrageur buying or selling an asset has to be cautious and limited about his investment positions. Noise traders could become more pessimistic or more bullish, so the arbitrageur has to take into consideration a risk for a further rise or fall of the share of the closed-end fund. This risk according is a noise trader risk and must be perceived by an arbitrageur to limit his trading positions against noise traders. For example, when the share of a closed-end fund is overpriced relative to its fundamental value as a result from irrational investors, then it represents a bad buy. Arbitrageurs or rational investors would open a short position to this expensive share and simultaneously purchase the same or very similar share in another market at a lower price to hedge their risks. The effect of this selling by arbitrageurs is to bring the price of the overpriced share down to its fundamental value. The total dataset includes monthly data starting from 1990 to 2020. The data was obtained from Thomson Financial Investment View database