Government debt has increased sharply in most developed countries in the wake of the financial crisis. The increased debt burden comes on top of an expected surge in debt due to demographics. Sharpened by the European peripheral debt crisis, this has led to increased focus on the risk associated with investing in government debt. This section reviews measures of this risk and discusses possible implications for investment returns.
In this section, we review the theory and empirical evidence of the term premium. The term premium is the excess return that an investor obtains in equilibrium from committing to hold a long-term bond instead of a series of shorter-term bonds.
In this section, we review the theory and empirical evidence of the credit premium. The credit premium is the excess return that an investor obtains for holding bonds issued by entities other than governments. A natural starting point for this objective is to discuss the so-called “credit spread puzzle” and different attempts to resolve it.
In this section, we discuss the potential long-term real return implications of current yield levels in developed economies’ government bond markets. Treasury yields in the major economies are at or very close to their historical lows. Forward-looking measures of real yields based on inflation-indexed bonds or on surveys of long-term inflation expectations are depressed.
This section provides a brief introduction to modern financial economics and theories of discount factor variation