Bond Term Premium Analysis in the Presence of Multiple Regimes

Abstract

This papers addresses whether observed violations in the liquidity preference hypothesis (LPH) can be explained by the presence of multiple regimes in the term premia. The investigation directly tests the LPH via a series of inequality tests which allow the moments to be conditioned on observable information using an instrumental variables approach. The apparent rejection of the LPH is then investigated by modeling the term premia over time using a simple Bayesian Markov mixture model. The results suggest the presence of time varying term premia and multiple regimes which may explain the apparent violations of the LPH.