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Modelling Time-varying Bond Risk Premia for Utilities Industry

Chadwick, Meltem (2010): Modelling Time-varying Bond Risk Premia for Utilities Industry.

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Abstract

This paper offers an alternative method for modelling bond risk premia for a panel of corporate bond yields using a daily data set for 48 corporate bonds of utilities industry over four years. This is done by using proxies for default, liquidity and interest rate factors that we get employing Fama and MacBeth two step procedure. In the meanwhile, the investors' learning process is mimicked by the Kalman filter procedure that is introduced to capture the dynamics of bond risk premia that are driven by multiple factors. In particular, we show that with time varying risk premia, our model performs much better in explaining our panel of bond returns when compared with the famous Fama-MacBeth two step procedure and rolling regression procedure, that are commonly used in the finance literature due to its merits of simplicity and clarity.

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