Simulating Long-Horizon Returns on Government Bonds

We outline a macro-finance model for simulating long-horizon returns on government bonds. We show how the determinants of return distributions change across different investment horizons and discuss differences in prospective returns on long- and short-duration bonds.

Using a realistic calibration, we show that it is unlikely that long-duration bond returns will match the experience in the past few decades. Assuming that macro trends are flat on average, the return distributions of short- and long-duration bonds are comparable, despite long-duration bonds earning a term premium. For long-duration bonds to generate returns closer to historical experience, long-term growth prospects would likely need to deteriorate from today’s levels.

An extended and refined version of the model outlined in the published paper is one of the building blocks of our AS Asset Market and Macro Model (ASAMM). It provides a forward-looking assessment of return and risk in international government bond markets. A key feature of the framework is that it links asset returns to macroeconomic outlook in a consistent manner, which enables a more accurate and more comprehensive risk assessment, including building macro scenarios and counterfactuals.