The US Treasury Term Premia in a Low Interest Rate Regime

This article aims to rationalize major shifts in yields and term premia for the U.S. Treasury securities since 1961. To this end, we build and estimate a Markov switching model that features a distinctive regime where short-term interest rates are at the effective lower bound (ELB). Our empirical results show that the conditional covariance between long-run consumption growth and target inflation became significantly more positive at the ELB, which is consistent with the economic theory. More importantly, this change led to nominal bonds being a better hedge against low economic growth, causing a downward shift in term premia and yields. In addition, we can generate yields that match the U.S. data.