Modelling Conditional Volatility of Risk Premia on Fixed Income Instruments

Konstantinos Drakos

Abstract

This paper attempts to model the conditional volatility of fixed income excess returns from the short-end of the Eurocurrency market term structure. Using daily data on the US and the UK term structures we explore whether an ARCH-M or an IGARCH-M model describe more adequately their conditional volatility. In addition, we explore the presence of asymmetries of shocks by estimating EGARCH and TARCH specifications. According to our results, the two term structures share some common features such as the absence of 'in-mean' effects, as well as asymmetries. They differ however in terms of the underlying specification that describes conditional volatility of premia. In particular, an IGARCH(1,1) model is more appropriate description of the US dollar excess returns' volatility, while an ARCH(4) model seems more appropriate for the Pound Sterling denominated excess returns' volatility.

JEL classification: C22, C32, E43
Keywords: Excess Returns, Eurocurrency, Fixed Income Markets, GARCH, Term Structure

Department of Economics, University of Patras, Rio, 26504, Patras, Greece, E-mail: kdrakos@upatras.gr

Acknowledgments

I would like to thank two anonymous referees for their insightful comments. Any remaining errors and ambiguities remain my responsibility.

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