The role of time‐varying rare disaster risks in predicting bond returns and volatility

Abstract

This paper aims to provide empirical evidence to the theoretical claim that rare disaster risks affect government bond market movements. Using a nonparametric quantiles‐based methodology, we show that rare disaster‐risks affect only volatility, but not returns, of 10‐year government bond of the United States over the monthly period of 1918:01 to 2013:12. In addition, the predictability of volatility holds for the majority of the conditional distribution of the volatility, with the exception of the extreme ends. Moreover, in general, similar results are also obtained for long‐term government bonds of an alternative developed country (UK) and an emerging market (South Africa).