This paper extends the benchmark Macro-Finance model by introducing, next to the standard macroeconomic factors, additional liquidity-related and return forecasting factors. Liquidity factors are obtained from a decomposition of the TED spread while the return-forecasting (risk premium) factor...

Standard approaches to building and estimating dynamic term structure models rely on the assumption that yields can serve as the factors. However, the assumption is neither theoretically necessary nor empirically supported. This paper documents that almost half of the variation in bond risk...