Is there a way one can decompose the yield of say a government bond with respect the the HJM framework? (into say an expectations component and a term premium component).

As far as I can see the HJM framework covers the "expectations hypotheses part" but not the term premium part if there is such a decomposition.


In the real world, many people believe that the yield of a government bond consists of an expectations part plus a term premium. However financial models such as HJM are built in a “risk -neutral” probability measure, with respect to which every asset is the expectation of future cash flows without regard to any term premium. This is done to ensure the models are arbitrage free versus the bonds or swaps with which it is calibrated.

  • $\begingroup$ I guess it means the model is suitable for some purposes (for example option valuation) but not for others (like - obviously - estimating term premiums). $\endgroup$
    – noob2
    Mar 10 '20 at 13:37
  • $\begingroup$ @dm63 so you agree that HJM only models the expectations part? and one has to add some suitable term premium to the the whole yield? $\endgroup$
    – user123124
    Mar 11 '20 at 11:23
  • $\begingroup$ What are you trying to do exactly ? $\endgroup$
    – dm63
    Mar 12 '20 at 0:32
  • $\begingroup$ @dm63 understanding how bonds work basically! I think I am well underway, ill post another question soon, maybe you can answer that one! Thanks for answering this btw $\endgroup$
    – user123124
    May 30 '20 at 12:15
  • $\begingroup$ @dm63 quant.stackexchange.com/questions/54533/… $\endgroup$
    – user123124
    May 30 '20 at 12:48

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