The standard class of affine models produces poor forecasts of future Treasury yields. Better forecasts are generated by assuming that yields follow random walks. The failure of these models is driven by one of their key features: Compensation for risk is a multiple of the variance of the risk. Thus risk compensation cannot vary independently of interest rate volatility. I also describe a broader class of models. These aessentially affine‐ models retain the tractability of standard models, but allow compensation for interest rate risk to vary independently of interest rate volatility. This additional flexibility proves useful in forecasting future yields.

Because the option to call a corporate bond should rise in value when bond yields fall, the relation between noncallable Treasury yields and spreads of corporate bond yields over Treasury yields should depend on the callability of the corporate bond. I confirm this hypothesis for investment-grade corporate bonds. Although yield spreads on both callable and noncallable corporate bonds fall when Treasury yields rise, this relation is much stronger for callable bonds. This result has important implications for interpreting the behavior of yields on commonly used corporate bond indexes, which are composed primarily of callable bonds.

Because the option to call a corporate bond should rise in value when bond yields fall, the relation between noncallable Treasury yields and spreads of corporate bond yields over Treasury yields should depend on the callability of the corporate bond. I confirm this hypothesis for investment‐grade corporate bonds. Although yield spreads on both callable and noncallable corporate bonds fall when Treasury yields rise, this relation is much stronger for callable bonds. This result has important implications for interpreting the behavior of yields on commonly used corporate bond indexes, which are composed primarily of callable bonds.

I document a dramatic increase in the importance of two types of variation in Treasury bill yields beginning in the early 1980s. The first is idiosyncratic variation in individual short‐maturity (less than three months) bill yields. The second is a common component in Treasury bill yields that is not shared by yields on other instruments, such as short‐maturity privately‐issued instruments or longer‐maturity Treasury notes and bonds. Some evidence suggests the first type reflects increased market segmentation. These results have important implications for the calibration and testing of no‐arbitrage term structure models and interpreting tests of the expectations hypothesis.

I document a dramatic increase in the importance of two types of variation in Treasury bill yields beginning in the early 1980s. The first is idiosyncratic variation in individual short-maturity (less than three months) bill yields. The second is a common component in Treasury bill yields that is not shared by yields on other instruments, such as short-maturity privately-issued instruments or longer-maturity Treasury notes and bonds. Some evidence suggests the first type reflects increased market segmentation. These results have important implications for the calibration and testing of no-arbitrage term structure models and interpreting tests of the expectations hypothesis.

The author documents a dramatic increase in the importance of two types of variation in Treasury bill yields beginning in the early 1980s. The first is idiosyncratic variation in individual short-maturity (less than three months) bill yields. The second is a common component in Treasury bill yields that is not shared by yields on other instruments, such as short-maturity privately issued instruments or longer-maturity Treasury notes and bonds. Some evidence suggests the first type reflects increased market segmentation. These results have important implications for the calibration and testing of no-arbitrage term structure models and interpreting tests of the expectations hypothesis.