Thursday, January 12, 2012

Quick Update on the Components of Bond Returns

In Real Squeeze, -1% Guaranteed Real Real Return! Yummy??, and Historical Sources of Bond Returns, I offer some historical perspective on the only sources of bond returns: inflation, real returns, and credit.  Assuming no credit risk in US Treasuries (probably not a good assumption given this Bloomberg quote on CDS on US Treasuries), the formula is fixed, and all inputs except inflation are provided ex-ante.  While bond prices can fluctuate wildly (Extreme Bond Returns), the experience over the life of a bond and a bond index is predetermined by the yield to maturity.  Unfortunately, that guaranteed experience in inflation or deflation is not so pleasant.

While everyone should know R, I understand that some readers would prefer an easier route.  FRED as usual comes to the rescue.  Unfortunately though, labeling is not allowed.  The codes can be translated as follows:

  • DBAA = total return on BAA
  • DBAA – (DGS10 – DFII10) = credit return
  • DGS10 – DFII10 = inflation (expected)
  • DGS10 = real return

In the spirit of continuous improvement, here is the chart now using lattice and latticeExtra.

From TimelyPortfolio

R code now in GIST:

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