Common factors in international bond returns

In this paper, we estimate and interpret the factors that jointly determine bond returns of different maturities in the US, Germany and Japan. We analyze both currency-hedged and unhedged bond returns. For currency-hedged bond returns, we find that a linear factor model with five factors explains 96.5% of the variation of bond returns. Using regression analysis, we show that these factors can be associated with changes in the level and steepness of the term structures in (some of) these countries. We compare our multi-factor model with one-dimensional (international) duration measures. The five-factor model also explains 98.5% of the cross-sectional variation in the expected bond returns in all countries. We find similar results when we jointly analyze both currency-hedged bond returns and bond returns that are not hedged for currency risk.