Term premiums

Term premiums

Excess of the yields to maturity on long-term bonds over those of short-term bonds.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

Term Premium

The amount by which the yield-to-maturity of a long-term bond exceeds that of a short-term bond. Because one collects coupons on a long-term bond for a longer period of time, its yield-to-maturity will be more. The amount of a term premium depends on the interest rates of the individual bonds.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved
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These could include upward pressures on global bond yields - as the compression of term premiums that followed QE is unwound - and a ratchet up in financial market volatility," Coulton noted.
On the downside, rich asset valuations and very compressed term premiums raise the possibility of a financial market correction, which could dampen growth and confidence."
Although a weaker dollar can be positive for corporate earnings and lower rates can be favourable for corporate borrowing, equity risk premiums remain wide because of the uncertainty expressed by low bond yields and negative term premiums.
Jonathan Wright suggested that another approach to avoiding the problem of the zero lower bound is to lower term premiums through asset purchases, which may be more politically feasible than raising the 2 percent inflation target.
Despite these views, the empirical relationship between the natural real rate and term premiums is not well understood.
People with little prospect of increasing their income sufficiently to pay ever-increasing term premiums face a difficult trade-off.
Risk-neutral yields increase, on average, in response to a positive surprise in the Fed funds rate, while term premiums fall, on average.
However, this relationship ignores term premiums and the policies directly aimed at lowering long-term yields in the unconventional policy period.
Crucially, Cluttons believes that through such public transportation infrastructure investments, the government is adding long term premiums to residential values and commercial rents.
The second strand of the literature uses lower-frequency (monthly) data to test the implication of the portfolio balance effect--namely, that there is a positive relationship between bond term premiums (and, consequently, bond yields) and the maturity structure of the publics holding of Treasury debt and long-term Treasury yields (e.g., Gagnon et al., 2011; Hamilton and Wu, 2012; Krishnamurthy and Vissing-Jorgensen, 2012; Greenwood and Vayanos, forthcoming).