An Equilibrium Model of Bond Pricing and a Test of Market Efficiency

Abstract

In two previous and related papers ([3], [4]), the authors have reported the results of estimating a particular equilibrium model of bond pricing using quarterly data on Canadian government bonds for the period 1964 to 1979. This paper reports the results of applying a similar model to the pricing of U.S. government bonds for the period 1958–1979 using data from the CRSP Government Bond File. The paper also extends the previous empirical analysis by evaluating the ability of the pricing model to detect underpriced and overpriced bonds: the data reveal a strong relation between price prediction errors and subsequent bond returns.