Macro Factors and Volatility of Treasury Bond Returns 1

Jingzhi Huang
McKinley Professor of Business and Associate Professor of Finance
Smeal College of Business
Pennsylvania State University
University Park, PA 16802, U.S.A.
Phone: (814) 863-3566
Email: jxh56@psu.edu

Lei Lu
Assistant Professor of Finance
School of Finance
Shanghai University of Finance & Economics
Shanghai, 200433, China
Phone: +86 (21) 6590-4161
Email: lu.lei@mail.shufe.edu.cn

1
We would like to thank Benjamin Croitoru, Hao Zhou, and seminar participants at Zhejiang University,
Shanghai Jiaotong University, Southwestern University of Finance and Economics, the 2008 Chinese
Finance Association annual meeting, and the 2008 Chinese Economic Association annual meeting for
helpful comments. We acknowledge the financial support from the Shanghai Pujiang Program and the
Shanghai University of Finance and Economics 211 Project-China
 Macro Factors and Volatility of Treasury Bond Returns

Abstract

This paper investigates the impact of macroeconomic variables on the volatility of

Treasury bond returns. By using principal components analysis, we extract the “real” and
“monetary” macro factors from the real activities and monetary variables, respectively.
We find that these macro factors have a significant impact on the volatility of Treasury
bond returns. In particular, we find that the real activities affect the return volatility
across all maturities, while the monetary variables are significantly related to the
volatility of short- and medium-term bonds only. The implication of these findings is that
the policy makers can employ monetary policy to stabilize the fluctuation of short- and
medium-term bonds, but need to take the real activities into account when stabilizing the
fluctuation of long-term bonds.

JEL classifications: E44; G12; G17

Keywords: bond volatility; real factor; monetary factor; volatility decomposition

1. INTRODUCTION

One important issue related to the Treasury bond market is the factors that affect the

volatility of Treasury bond returns. Viceira [2007] finds that the short-term nominal

interest rates positively forecast bond volatility. Jones, Lamont, and Lumsdaine [1998],

Christiansen [2000], and Goeij and Marquering [2006] find that the announcements of

macroeconomic variables significantly affect the volatility of Treasury bond returns.

Fleming and Remolona [1999] and Balduzzi, Elton, and Green [2001] also study the

impact of macro news on bond volatility and other features of bond markets (e.g., trading

volume and liquidity) using different sets of macroeconomic announcements. Recent

empirical evidence further documents that releases of macroeconomic news affect the

shape of the term structure of the bond volatility. For instance, Goeij and Marquering

[2006] find that releases of employment data and producer price index have an effect on

the volatility of medium- and long-term bond returns, while the announcements of

monetary policy only affect short-term bond volatility.

However, few studies have examined whether macroeconomic fundamentals

themselves can predict the volatility of Treasury bond returns. This question is interesting

especially given that Ludvigson and Ng [2009] find that the macroeconomic

fundamentals greatly affect bond returns and then bond risk premia. A related question is

whether monetary variables (rather than their announcements) have different effects on

the volatilities of bond returns with different maturities. In this paper, we provide perhaps

the first attempt to answer the above two questions.

Specifically, we first extract the “real” and “monetary” factors from the

1
macroeconomic variables using the principal components analysis. We then examine the

impact of both the “real” and “monetary” factors on the volatilities of bond returns. Next,

to disentangle the impacts of maturity on the volatility of bond returns from that caused

by market risk, we decompose the bond volatility for each maturity into market-level

volatility and maturity-dependent volatility and then rerun the regression separately using

the two volatility components.

We find that macroeconomic variables significantly affect the bond volatility and its

two components. Specifically, the real activities affect the bond volatility of all maturities,

while the monetary variables are significantly related to the volatility of short- and

medium-term bonds (e.g., 1-, 2-, 5-, and 7-year) and have no influence on the volatility of

long-term bonds. The implication of these findings is that the policy makers can employ

monetary policy to stabilize the fluctuation of short- and medium-term bonds, while they

need to take the real activities into account when stabilizing the fluctuation of long-term

bonds. Moreover, our results suggest that macroeconomic variables can be good

predictors for volatility of Treasury bond returns, in particular, the real activities and

monetary variables differently affect the volatilities of bond returns with different

maturities.

This paper contributes to the literature at least in two aspects. First, existing studies

(e.g., Jones, Lamont, and Lumsdaine [1998]; Christiansen [2000]; and Goeij and

Marquering [2006]) focus on the effects of macroeconomic announcements on the

volatility of bond returns, but none of them investigate the relationship between the

macroeconomic variables and bond volatility. David and Veronesi [2008] find that

investors’ beliefs about fundamentals (proxied by investors’ uncertainty about economy)

2
can improve the predictability of bond volatility by controlling macroeconomic variables,

while the macro variables include the interest rates measures, the fundamental volatilities,

and the NBER index. In our paper, the macroeconomic variables include the real

activities and monetary variables. In particular, we find that “real” and “monetary”

factors have different impacts on the volatility of bond returns across various maturities.

Second, to the best of our knowledge, this is the first paper to decompose the

volatility of Treasury bonds into two components—market-level and maturity-dependent

volatility—and then examine the relationship between each of the volatility components

and certain macroeconomic variables. As such, our paper differs from the study by Goeij

and Marquering [2006], which examines the impact of macro announcement on bond

volatility using the intraday data whereas we investigate the effects of macroeconomic

variables on both market-level volatility and maturity-dependent volatility using the daily

bond return. The maturity-dependent volatility of bond returns has the same sprit of

idiosyncratic volatility in the stock market. To some degree, our paper can be treated as a

long-run predictability of bond volatility, while Goeij and Marquering [2006] predict the

bond volatility in short run.

2. DATA

2.1 Bond Data

We examine the volatility of 1-, 2-, 5-, 7-, 10-, 20- and 30-year U.S. Treasury bonds.

The data on bond returns for the period July 1961 through December 2008 are obtained

3
from the CRSP Daily Treasury Fixed-term File. 2 The excess returns are calculated using

the bond returns in excess of the 3-month Treasury-bill rates, taken from the Federal

Reserve Board of Governors.

EXHIBIT 1
Descriptive Statistics of Daily Excess Bond Returns
This exhibit presents the sample statistics of daily returns on 1-, 2-, 5-, 7-, 10-, 20-, and 30- year
Treasury bonds in excess of the 3-month Treasury-bill rates for the period July 1961 through
December 2008. The bond returns are obtained from the CRSP Daily Treasury Fixed-term File.
The 3-month Treasure-bill rates are taken from the Federal Reserve Board of Governors.

1-year 2-year 5-year 7-year 10-year 20-year 30-year

Mean (%) 0.025 0.026 0.028 0.029 0.027 0.029 0.027
Median (%) 0.020 0.020 0.0200 0.020 0.017 0.0190 0.010
Stdev (%) 0.076 0.141 0.301 0.370 0.457 0.603 0.629

Exhibit 1 reports the descriptive statistics of daily excess returns. As can be seen

from the table, the average daily excess return does not vary significantly across

maturities and ranges from 2.5 bps for 1-year bonds to 2.9 bps for 7-year bonds. On the

other hand, the bond volatility has a significant variation across maturities, ranging from

0.076% for 1-year bonds to 0.629% for 30-year bonds.

We obtain the face value of outstanding debt from the CRSP Daily Treasury Master

File and the bid and ask bond prices from the CRSP Daily Treasury Fixed-term File. The

market capitalization of the bond market is calculated by multiplying the debt outstanding

by the average of market bid and ask price.

2
According to the CRSP Daily Treasury Fixed-term File, the daily holding period return is defined as the
price change plus interest, divided by last day’s price. In Jones, Lamont, and Lumsdaine [1998], the daily
returns are calculated from the Federal Reserve’s constant maturity interest rate series. They calculate the
bond yield from the interest rates and then derive the end-of-period bond price using the next day’s yield
augmented with the accrued interest rate, and the holding
4 period return equals the change in bond price.
 2.2 Macroeconomic Variables

The monthly macroeconomic variables are collected from the database of Global

Insight Basic Economics for the period May 1961 through December 2008. The variables

we consider are classified into the two categories of real activities and monetary variables.

The variables of real activities include the index of Help Wanted Advertising in

Newspaper (LHEL), the unemployment rate (LHUR), the industrial production index

(IPS10), and the National Association of Production Management (NAPM) production

index (PMP). All of these variables except PMP are used by Ang and Piazzesi [2003] to

reflect the real activities. The monetary variables consist of the Federal funds rates

(FYFF), nonborrowed reserves (FMRNBA), and M2 (FM2). From October 1979 to

August 1982, FMRNBA was chosen as the policy target, and for the rest of the sample

period FYFF was chosen as the target by the Federal Reserve. Exhibit 2 describes the real

activities and monetary variables used in our analysis.

EXHIBIT 2
Description of Macroeconomic Variables
This exhibit describes the real activities and monetary variables used in the paper. In the
transformation column (Trans), lv denotes the level of the series, ∆lv denotes the difference of the
level, ∆ln denotes the first difference of logarithm, and ∆2ln denotes the second difference of
logarithm. Data on all series are obtained from the Global Insight Basic Economics database.

Series Mnemonic Description Trans

Real Activities
1 LHEL Index of Help-Wanted Advertising in Newspapers ∆ln
2 LHUR Unemployment Rate: All Workers, 16 Years & Over ∆lv
3 IPS10 Industrial Production Index ∆ln
4 PMP NAPM Production Index lv
Monetary Variables
1 FYFF Federal Funds Rate ∆lv
2 FMRNBA Non-borrowed Reserves ∆2ln
3 FM2 Money Stock: M2 ∆2ln

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 Following Stock and Watson [2002] and Ang and Piazzesi [2003], we use principle

component analysis to estimate the common factors for each group of variables,

respectively. First, we transform the series of variables to be stationary. Exhibit 2

summarizes all the transformations that are used. Next, we standardize each series

separately to have a mean of zero and unit variance. Then consider the following

specifications:

X i (t ) = β i f i (t ) + ε i (t ), i = R, M . (1)

where X R = (LHEL, LUHR, IPS10, PMP ) and X M = (FYFF , FMENBA, FM 2 )

denote the vectors of real activity and monetary variables, respectively. f R

and

f M
represent the “real” and “monetary” factors, respectively.

The principal component analysis indicates that the first “real” factor accounts for

57.0% of the variance of real activity variables. This factor loads a significant amount of

information about the real variables and can be used to measure the real activities.

Similarly, the first “monetary” factor accounts for 46.5% of the variance of monetary

variables and is used as a proxy for the monetary variables. The correlations between the

first “real” factor and the four real variables are -0.668, 0.722, -0.799, and -0.820,

respectively. We should be cautious in explaining the signs of correlations. As we

anticipated, as the LHEL, IPS10, and PMP increase and the LHUR decreases, the

economy tends to be healthy. Therefore, the signs of the correlations have reversed

economic meaning.

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 The correlations between the first “monetary” factor with the three monetary

variables are -0.809, 0.697, and 0.503. Similar to the explanation of signs of correlations

between “real” factor and real activities, the signs of the correlations have reversed

economic meaning for “monetary” factor. As the economy becomes healthy, the funds

rate tends to be high and thus attracts more investors to invest in the long-term bonds.

The signs of these correlations are intuitive: to maintain a level of total reserves

consistent with the FOMC's target federal funds rate, increases in borrowed reserves must

generally be met by a decrease in nonborrowed reserves, and therefore the FMRNBA and

the FYFF are negatively correlated. Moreover, the first “real” and “monetary” factors are

weakly correlated with a value of -0.118.

EXHIBIT 3
Correlations Matrix among (Real and Monetary) Factors and Bond Volatility
This exhibit presents the correlations between the realized volatility of 1-, 2-, 5-, 7-, 10-, 20-, and
30- year bonds and the one-month lagged “real” and “monetary” factors. The correlations among
bond volatilities are also reported in the following exhibit.

1-year 2-year 5-year 7-year 10-year 20-year 30-year

Real-1 0.295 0.314 0.254 0.219 0.249 0.244 0.260
Money-1 0.066 0.093 0.060 0.046 0.022 0.029 0.028
1-year 1
2-year 0.796 1
5-year 0.593 0.724 1
7-year 0.584 0.737 0.874 1
10-year 0.486 0.610 0.740 0.734 1
20-year 0.464 0.586 0.765 0.731 0.691 1
30-year 0.474 0.613 0.626 0.682 0.656 0.707 1

Exhibit 3 reports the correlations between the macro factors and the bond volatility

of various maturities, from which we can gain the preliminary information about their

relationship. We find that the “real” factor is highly correlated with the bond volatility

7
and that the correlations are almost the same for all maturities (ranging from 0.219 to

0.295), while the “monetary” factor is weakly correlated with bond volatility. In

particular, the correlation of the “monetary” factor with 1- and 2-year bond volatility is

higher than that with 20- and 30-year bond volatility—e.g., 0.066 and 0.093 vs. 0.029 and

0.028. This suggests that the “real” factor might be significantly related to the bond

volatility of all maturities, while the “monetary” factor weakly affects the bond volatility

and its effect can be not significant for the volatility of long-term Treasury bonds. 3 These

conjectures is examined and confirmed in the following section.

Exhibit 3 also reports the correlations of volatility between different maturities. It is

not surprising that the correlations decrease as the difference of maturities increases,

since the expectation hypothesis claims that the volatility of long-term bond yields is on

average the sum of volatilities of short-term bond yields.

3. EMPIRICAL RESULTS

The objective of this analysis is to investigate if the volatility of Treasury-bond

returns is related to the macro factors and, in particular, if the bond volatility of different

maturities is driven by different macro factors. To proceed, we first regress the bond

volatility on the macro factors for each maturity. Next, we decompose the bond volatility

of each maturity into the bond-market-level volatility and the maturity-dependent

volatility. Then we separately regress these two sets of volatiles on the macro factors.

3
In this paper, we call 1- and 2-year bonds the short-term bonds, 5- and 7-year bonds the medium-term
bonds, and 10-, 20-, and 30-year bonds the long-term8bonds.
 3.1 Preliminary Analysis

We use one-month lagged “real” and “monetary” factors, lagged logarithmic

nominal short rate proxied by the 3-month Treasury-bill rate, and lagged volatility value

to forecast the bond volatility. Because Viceira [2007] finds that the nominal short-term

interest rates positively forecast the bond volatility, we also include this variable in the

regression models.

Exhibit 4 presents the estimated results for the monthly volatility of Treasury bonds

on the lagged “real” and “monetary” factors, the lagged log short rate, and the lagged

volatility value. The first column shows that the “real” factor positively and significantly

affects the bond volatility across all maturities. The positive impact of “real” factor on

volatility of Treasury bonds and the negative correlations between “real” factor with

LHEL, IPS10, and PMP imply that the higher the LHEL, IPS10, and PMP, the lower the

volatility of Treasury bonds. This is intuitive: as the LHEL, IPS10, and PMP become

larger, the economy tends to be healthier, the uncertainty of economy decreases, and thus

the volatility of Treasury bonds is decreased. This is consistent with David and Veronesi

(2008), which find that the investors’ uncertainty about economy can negatively predict

the bond volatility. Moreover, since the volatility of long-term Treasury bonds is

generally higher than that of short-term Treasury bonds, it is not surprising that the

estimated coefficients of “real factor” are higher for the long-term bonds. It is about 0.45

for 1-year Treasury bonds and 2.10 for 30-year Treasury bonds.

The second column shows that the “monetary” factor is strongly related to the

volatility of short- and medium-term Treasury bonds (e.g., 1-, 2-, 5-, and 7-year bonds),

while it is not statistically significant for long-term Treasury bonds (e.g., 10-, 20- and 30-

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EXHIBIT 4
Estimates of Real and Monetary Factors on Total Bond Volatility
This exhibit reports the regression results of monthly realized volatility of 1-, 2-, 5-, 7-, 10-, 20-,
and 30- year bonds on the lagged “real” factor Real -1, the lagged “monetary” factor Money -1, the
lagged log short rate r-1, and the lagged bond volatility. The t-values are reported in the brackets.

Real -1 Money -1 r-1 Vol-1 R2

1-year
0.433 (3.979) 0.506 (13.878) 0.320
0.476 (4.398) 0.502 (3.688) 0.512 (14.190) 0.337
0.418 (3.919) 0.461 (3.448) 1.535 (4.960) 0.451 (12.036) 0.365
2-year
0.678 (3.968) 0.620 (18.889) 0.449
0.859 (4.004) 0.665 (21.193) 0.450
0.769 (4.549) 0.5973 (4.581) 0.622 (19.279) 0.469
0.693 (4.149) -0.924 (4.421) 2.222 (4.538) 0.567 (16.690) 0.488
5-year
1.716 (3.990) 0.437 (11.573) 0.245
1.897 (4.281) 1.368 (2.419) 0.436 (11.593) 0.253
1.685 (3.782) 1.297 (2.307) 3.796 (3.026) 0.414 (10.858) 0.265
7-year
1.381 (2.839) 0.522 (14.468) 0.307
1.506 (3.081) 1.283 (2.049) 0.522 (14.499) 0.312
1.292 (2.622) 1.211 (1.942) 3.695 (2.662) 0.504 (13.841) 0.321
10-year
2.471 (3.621) 0.440 (11.593) 0.243
2.593 (3.847) 1.256 (1.463) 0.440 (11.605) 0.246
2.367 (3.468) 1.183 (1.381) 3.626 (1.919) 0.431 (11.331) 0.251
20-year
2.679 (3.299) 0.532 (14.900) 0.326
2.838 (3.472) 1.606 (1.539) 0.531 (14.895) 0.329
2.563 (3.100) 1.519 (1.458) 4.592 (1.992) 0.521 (14.472) 0.334
30-year
2.054 (2.835) 0.592 (17.169) 0.389
2.191 (3.002) 1.343 (1.457) 0.590 (17.145) 0.391
2.028 (2.737) 1.294 (1.404) 2.530 (1.250) 0.587 (16.999) 0.393

year bonds). For example, when we regress on lagged “real” and “monetary” factors and

lagged bond volatility for 1-year Treasury bonds, the coefficient for “monetary” factor is

0.502 with t-value of 3.688. We need emphasize two issues with the regression results.

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First, the positive impact of “monetary” factor on bond volatility has the same intuition as

that for “real” factor: the higher the “monetary” factor, the lower the fund rate (because

of the negative correlation with “monetary” factor), the worse the economy, and thus the

higher the bond volatility. Second, since the correlation between “real” and “monetary”

factors is negative, the estimation coefficients of “real” factor become larger when we

include the “monetary” factor into the regressions.

The above results confirm our preliminary results that the “real” factor significantly

and positively affects the bond volatilities of all maturities, while the “monetary” factor is

only related to the bond volatility of short- and medium-term bonds as illustrated in

Exhibit 3. Our results are consistent with Viceira [2007], who finds that the nominal short

rate significantly affects the stock and bond volatility up to a 60-month horizon. In our

paper, we analyze the 1-month excess bond returns and find that the nominal short rate

has significant effect on the volatility of bonds for all maturities, while its influence on

the volatility of 30-year bonds is relatively limited.

Our findings are also consistent with those of Evans and Marshall [1998] and Goeij

and Marquering [2006]. Evans and Marshall [1998] find that a contractionary monetary

policy shock induces a pronounced positive but transitory response in short-term interest

rates and has a smaller effect on medium-term rates and almost no effect on long-term

rates. Goeij and Marquering [2006] find that the announcements of monetary policy only

affect the volatility of short-term bonds. However, this paper focuses on the connection

between bond volatility and monetary variables.

11
 3.2 Empirical Analysis

Campbell, Lettau, Malkiel, and Xu [2001] decompose the stock volatility into three

components—market-level, industry-level and firm-specific volatilities, and they find

that these three components have different patterns over time. Following their method,

we decompose the volatility of government bonds into bond-market-level and maturity-

dependent volatility.

Maturity is denoted by subscript i, and the excess bond return with maturity i is

denoted by ri B . The bond market capitalization for maturity of one year or greater is

calculated on the basis of all seven categories of Treasury bonds. The weight of maturity i

in the total bond market is denoted by wi , and the excess bond market return

is r B = ∑i =1 wi ri B . In the next step, we decompose the excess bond return on each

7

maturity by using the CAPM 4 given by

ri B (t ) = α B + β iB (t )r B (t ) + vi (t ). (2)

Following French, Schwert, and Stambaugh [1987] and Schwert [1989], we use the

daily bond returns to calculate the realized monthly volatility. Because r B (t ) and vi (t )

are orthogonal, the variance of bond returns is therefore

( ) ( )
Var ri B (t ) = Var β iB (t )r B (t ) + Var (vi (t )), (3)

4
Viceira [2007] uses the stock market returns to calculate the realized bond CAPM beta as a proxy for
bond risk. 12
where Var (ri B ) , Var (β iB r B ) , and Var (vi ) are called the total bond variance, the risk-

adjusted variance of the bond-market, and the maturity-dependent bond variance,

respectively. To differentiate from the risk-adjusted variance of the bond market, we call

( )
Var r B the variance of the bond market. Moreover, we denote the total bond volatility of

maturity i, the risk-adjusted volatility of the bond-market-level, the volatility of the bond-

market-level, and the maturity-dependent volatility by σ iB ≡ Var (ri B ) ,

σ iβB ≡ Var (β iB r B ) , σ B ≡ Var (r B ) , and σ iv ≡ Var (vi ) , respectively.

In calculating the two components of total bond volatilities, we follow Fama and

French [2005] and Ang and Chen [2007] to assume that the CAPM betas vary over time.

To calculate the time-varying CAPM betas for each month, we regress the daily excess

bond returns of maturity i on the daily bond-market returns like Equation (2) to gain the

series of monthly betas.

To well understand the maturity-dependent bond volatility, we calculate the ratio of

maturity-dependent bond volatility, σ iv to the total bond volatility, σ iB , for each maturity.

We find that the ratios are higher for the 1- and 2- year Treasury bonds than for the others.

This ratio is on average 0.552 and 0.333 for 1- and 2-year bonds, and 0.159 and 0.122 for

20- and 30-year bonds, respectively. This means that the maturity-dependent volatility is

more important in explaining the total volatility of short-term bonds than of long-term

bonds.

In the previous section, we studied the impact of “real” and “monetary” factors on

total bond volatility of each maturity. The next step is to investigate the impacts of “real”

13
and “monetary” factors on the two components of total volatility: the bond-market-level

volatility, σ B , and the maturity-dependent volatility, σ iv .

EXHIBIT 5
Estimate of Real and Monetary Factors on Bond Market Level Volatility
This exhibit reports the regression results of monthly bond-market-level volatility on the lagged
“real” factor Real -1, the lagged “monetary” factor Money -1, the lagged log short rate r-1, and the
lagged bond volatility. The t-values are reported in the brackets.

Real -1 Money -1 r-1 Vol-1 R2

0.869 (2.677) 0.694 (22.738) 0.515
0.952 (2.915) 0.814 (1.967) 0.692 (22.737) 0.519
0.867 (2.623) 0.788 (1.904) 1.419 (1.551) 0.686 (22.346) 0.521

Exhibit 5 presents the regression results of “real” and “monetary” factors on the

bond-market-level volatility. For all combinations of explanatory variables, the

coefficients of the “real” factor are positive, and the t-values demonstrate that the “real”

factor significantly affects the bond-market-level volatility. When we regress on lagged

“real” factor and lagged bond volatility, the coefficient of “real” factor is 0.869 with the t-

value of 2.677. By including “monetary” factor and short rate, the coefficients become

0.952 and 0.867 with t-values of 2.915 and 2.623, respectively.

The second column reports the regression results for the “monetary” factor. In

general, we find that the “monetary” factor is not significant or marginal significant,

although it is still negatively correlated with the bond-market-level volatility. When we

regress on “real” and “monetary” factors and lagged bond volatility, the t-value for

“monetary” factor is 1.967, while it insignificant with t-value of 1.904 when including

short rate. The possible reason is that the effect of the “monetary” factor on the maturity-

EXHIBIT 6
14
Estimates of Real and Monetary Factors on Maturity Dependent Bond Volatility
This exhibit reports the regression results of monthly maturity-dependent volatility on the lagged
“real” factor Real -1, the lagged “monetary” factor Money -1, the lagged log short rate r-1, and the
lagged bond volatility. The t-values are reported in the brackets.
Real -1 Money -1 r-1 Vol-1 R2
1-year
0.342 (3.929) 0.423 (11.013) 0.238
0.365 (4.187) 0.283 (2.561) 0.431 (11.229) 0.247
0.309 (3.619) 0.240 (2.225) 1.369 (5.507) 0.360 (9.109) 0.286
2-year
0.432 (4.260) 0.566 (16.327) 0.396
0.457 (4.486) 0.257 (2.025) 0.566 (16.366) 0.400
0.411 (4.132) 0.225 (1.819) 1.636 (5.592) 0.488 (13.399) 0.432
5-year
0.755 (4.713) 0.423 (11.138) 0.253
0.799 (4.976) 0.480 (2.364) 0.425 (11.228) 0.260
0.707 (4.430) 0.437 (2.182) 1.942 (4.289) 0.383 (9.936) 0.284
7-year
0.662 (4.035) 0.543 (15.384) 0.359
0.718 (4.387) 0.663 (3.205) 0.549 (15.663) 0.371
0.624 (3.911) 0.578 (2.873) 2.849 (5.959) 0.462 (12.486) 0.408
10-year
0.699 (3.404) 0.601 (17.882) 0.411
0.679 (3.282) -0.214 (-0.817) 0.601 (17.866) 0.412
0.559 (2.741) -0.280 (-1.089) 3.029 (5.048) 0.539 (15.360) 0.437
20-year
1.010 (3.294) 0.360 (9.179) 0.162
1.029 (3.327) 0.198 (0.494) 0.360 (9.181) 0.163
0.781 (2.543) 0.097 (0.246) 4.470 (4.986) 0.303 (7.560) 0.198
30-year
1.304 (3.897) 0.278 (6.825) 0.123
1.364 (4.057) 1.681 (1.582) 0.280 (6.892) 0.127
1.212 (3.568) 1.626 (1.460) 2.474 (2.617) 0.266 (6.528) 0.138

dependent volatility of short- and medium-term Treasury bonds has been removed

leaving the effect of the “real” factor on the volatility of bond-market-level.

Exhibit 6 presents the estimates of “real” and “monetary” factors on the maturity-

dependent volatility. This analysis further investigates the effects of macroeconomic

variables on the volatilities of treasury bonds with various maturities. The first column

15
shows that the “real” factor positively and significantly affects the maturity-dependent

volatility of all maturities with most of the t-values greater than 3. Th economic

explanation is the same as that for total bond volatility of each maturity (e.g., see Exhibit

4). The second column reports the regression results for “monetary” factor. We find that

its coefficient is positively and statistically significant for Treasury bonds with maturity

up to seven years, while it becomes insignificant for Treasury bonds with maturity of 10

years or greater. It has the same regression results and economic intuition for total bond

volatility.

3.3 Robustness Check

In this section, we provide the robustness check to examine the relationship

between macroeconomic factors with volatility of Treasury bonds.

Constant Betas: In Campbell, Lettau, Malkiel, and Xu [2001], the CAPM betas are

assumed to be constant. We use the whole samples to run model (2) and thus we can

calculate the bond-market volatility and maturity-dependent bond volatility, respectively.

The regression results show that this does not change our conclusions qualitatively.

Stock Market Index: Viceira [2007] uses the stock market returns to calculate the

realized bond CAPM beta as a proxy for bond risk. As a robustness check, we replace the

index of bond market returns by the stock market index (e.g., daily returns on the value-

weighted portfolio of all stocks traded on the NYSE, the AMEX, and the NASDAQ) and

run the regression models, we have the similar estimation results for “real” and

“monetary” factors.

Equally-Weighted Index: In this section, we use the equally-weighted bond

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returns across various maturities to replace the value-weighted bond returns and run the

regression models, we find that the “monetary” factor is significantly related to the return

volatility of short-term bonds (e.g., 1- and 2-year) and weakly related to the volatility of

medium-term bonds (e.g., 5- and 7-year), while it has no influence on the return volatility

of long-term bonds (e.g., 10-, 20-, and 30-year).

In summary, when we decompose the bond volatility into the market-level volatility

and the maturity-dependent volatility, we find that the macro factors significantly affect

the maturity-dependent bond volatility. In particular, the “real” factor affects the bond-

return volatility across all maturities, while the “monetary” variables are related to the

return volatility of short- and medium-term bonds, and have no influence on the return

volatility of the long- term bonds.

4. CONCLUSION

This paper investigates the impact of macro variables on the volatility of Treasury

bond returns. We extract the “real” and “monetary” factors from the real activities and

monetary variables, respectively. Then we examine the two factors’ impact on the daily

volatility of the 1-, 2- 5-, 7-, 10-, 20-, and 30-year U.S. Treasury bonds. We find that

both “real” and “monetary” factors significantly affect the bond return volatility. In

particular, the “real” factor affects the volatility across all maturities, while the monetary

variables are significantly related to the volatility of short- and medium-term bonds. An

extension is to analyze the relationship between the maturity-dependent volatility and the

bond return for each maturity, which has the same spirit of idiosyncratic volatility in

17
predicting the stock market return.

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