Disaster risk matters in the bond market

We propose a rare disaster risk indicator and study its predictive power on the returns of U.S. Treasury bonds. The rare disaster risk factor is extracted from rare disaster concern proxies using partial least square method. Empirical results indicate that disaster risk significantly predicts time-varying bond risk premium. The predictive power is significant both in- and out-of-sample. Furthermore, the spanning test results suggest that information content of disaster risk indicator is not spanned by the current yield curve.