N°25-95: What 200 Years of Data Tell Us About the Predictive Variance of Long-Term Bonds

This paper investigates the long-horizon predictive variance of an international bondstrategy where a U.S. investor holds unhedged positions in constant-maturity long-term foreign bonds funded at domestic short-term interest rates. Using over two centuries of data from major economies, the study finds that predictive variance grows with the investment horizon, driven primarily by uncertainties in interest rate differentials and exchange rate returns, which outweigh mean reversion effects. The analysis, incorporating both observable and unobservable predictors, highlights that unobservable predictors linked to shifts in monetary and exchange rate regimes are the dominant source of long-term risk, offering fresh insights into international bond investment strategies.