Approaches to Long-Term Fixed-Income Capital Market Assumptions
Summary
The document outlines ways to set long-term capital market assumptions for fixed-income assets, including government bonds and high-yield credit. One approach builds expected returns from a cash-return estimate plus relevant premia, such as government bond and credit risk premia. The answer cautions that forecasting cash returns and estimating forward-looking premia are both difficult.
It also points to published institutional methodologies and argues that simpler approaches can work well for long-term fixed-income forecasts. As an example, it describes comparing the current yield on rolling ten-year government bonds with their realized return over the following ten years. Expected rolldown could refine this simple relationship, though the document questions whether extra complexity is worthwhile. The evidence is described through a chart but not reproduced here, and the discussion offers no detailed forecasting procedure or quantified comparison of methods.
Key ideas
- A building-block approach adds relevant bond and credit risk premia to an expected cash return.
- Forecasting cash rates and estimating ex-ante risk premia are both challenging.
- Current government bond yields can serve as a simple reference for long-horizon realized returns.
- Expected rolldown may refine yield-based forecasts, but added complexity may have limited value.
- The document summarizes approaches but does not provide a complete forecasting model or numerical evaluation.
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# Bond asset class long term assumptions # Bond asset class long term assumptions How are long term capital market expectations set in the industry? I'm looking to get some pointers about setting long term assumptions for fixed income asset classes like global high yield credit, or government bonds and how we could model or forecast the yield. We could probably use term premia or add a liquidity premia to the current yield, then the question becomes one of estimating these premia... ## Answer by Helin (score 4) https://quant.stackexchange.com/a/39011 Broadly speaking, there are three approaches to setting long-term Capital Market Assumptions (CMA): - Building-block approach: This approach starts with the expected return for cash, then adds various relevant risk premia. In the context of fixed income assets, we'd be adding bond risk premium for risk-free government bonds, credit risk premium for credits, etc., as you've alluded to. (This is ridiculously popular, but I tend to dislike it. Cash return is impossible to forecast accurately because of uncertainties surrounding monetary policy cycles, and estimating ex-ante risk premium is no easy thing either.) I won't go into the details of these methods because there are excellent whitepapers written by smarter people. Some of my favorites include: - AQR's publishes Capital Market Assumptions for Major Asset Classes yearly; - Research Affiliate provides an in-depth discussion of their approach for fixed income assets; - Rebeco also provides detailed documentation for their methodology across assets; - Global Endowment Management's CMAs are based on different approaches, depending on the assets in question. I'll also comment that for generating long-term CMAs, simpler methods are usually very successful; this is particularly true for fixed income assets. For example, the chart below shows 10-year bond yield versus next 10-year realized return of continuously rolling on-the-run 10-year Treasuries. You can marginally improve upon this result (e.g., by including an expected rolldown return), but I wonder whether it's worth the effort.
Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.