Bond risk premiums at the zero lower bound

We document that the spread between long- and short-term government bond yields is a stronger predictor of excess bond returns when the U.S. economy is at the zero lower bound (ZLB) than away from this bound. The Gaussian shadow rate model with a linear or quadratic shadow rate is unable to explain this change in return predictability. The same holds for the quadratic term structure model and the autoregressive gamma-zero model that also enforce the ZLB. In contrast, the linear-rational square-root model explains our new empirical finding because the model allows for unspanned stochastic volatility as seen in bond yields.