The Maturity Structure of Term Premia with Time-Varying Expected Returns

This paper analyzes the maturity structure of term premia using McCulloch's yield curve data from 1953-91 under both constant and time-varying expected returns assumptions. Time-varying expected returns are computed as linear projections of one-, three-, six-, and twelve-month holding period returns on three ex ante observable variables. The likelihood of expected returns monotonically increasing in maturity, as implied by the liquidity preference hypothesis, and other patterns are assessed via Monte Carlo simulations. Monotonicity well-characterizes the data over the 1983-91 subsample but not the other periods. The ex ante variables' contributions to term premia are consistent across subsamples and holding periods: Interest rate volatility is associated with a declining maturity structure, while the level of interest rates and the slope of the yield curve are associated with an increasing maturity structure