The time-varying bond risk premia in China

Unlike many developed countries in which zero interest rate policies are widely adopted, there is still room for interest rate fluctuations in China. Nevertheless, the dynamics of bond yields, forward rates and risk premia still differ from the traditional understanding. This paper focuses on the Chinese treasury bonds. By OLS regressions, we find movements in the current forward rate fully reflect future bond risk premia, while other variables do not improve its performances, regardless of in-and out-of-sample predictions. This result is confirmed by a group of no-arbitrage dynamic term structure models. Moreover, the theoretical models reveal three important findings: 1. there are about 20% predictable variations in annual excess returns; 2. only the level factor risk is priced; 3. the candidate macroeconomic variables cannot contribute to the term premia structure.