Investor sentiment and bond risk premia

This article studies the statistical significance of the set of market sentiment variables proposed by Baker and Wurgler (2006) to predict the risk premium on U.S. sovereign bonds. We show that these variables can be summarized in one single market sentiment factor similar in spirit to the single-return forecasting factor proposed by Cochrane and Piazzesi (2005). Our findings reveal that this factor has predictive power beyond that contained in the yield curve and benchmark macroeconomic factors. The predictive power of this variable is time-varying, exhibiting more relevance during recession periods.