Trading the Term Premium

The proliferation of factor investing strategies in recent years has highlighted the idea that a portfolio can harvest improved risk-adjusted returns through timed exposure to risk factors during times of elevated risk premia. While there is a large body of research on such risk factors and risk premia in equity markets, there has been relatively little research on the topic in fixed income markets.One such fixed income risk factor that has begun to receive interest from practitioners and academics is the term premium, the risk premium associated with duration risk in bonds. Adrian et al. (ACM) (2013) introduced a sophisticated affine term structure model which is able to efficiently estimate the term premium using linear regressions. While the model appears to align with economic theory, little work has been done on investigating practical applications of the term premium in timing exposure to duration risk in a bond portfolio.This report investigates the practical applicability of the ACM model in the South African and United States sovereign bond markets, finding that signals generated from the model are able to capture regimes of increased risk-adjusted returns. Using these signals in systematic strategies also generates promising results