International Bond Risk Premia

We identify local and global factors across international bond markets that arepoorly spanned by the traditional level, slope and curvature factors but havestrong forecasting power for future bond excess returns. Local and global fac-tors are jointly signicant predictors of bond returns, where the global factor isclosely linked to US bond risk premia and international business cycles. Moti-vated by our results, we estimate a no-arbitrage ane term structure model foreach country in which movements in risk premia are driven by one local andone global factor. Yield loadings for the two factors are estimated to be close tozero while shocks to risk premia account for a small fraction of yield variance.This suggests that the cross-section of yields conveys little information about thereturn-forecasting factors. We show that shocks to global risk premia cause o-setting movements in expected returns and expected future short-term interestrates, leaving current yields little aected. Furthermore, correlations betweeninternational bond risk premia have increased over time, indicating an increasein integration between markets.