The U.S. Treasury Term Premia in a Low Interest Rate Regime

Abstract 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.