[We develop a model of nominal and real bond yield curves that has four stochastic drivers but seven factors: three factors primarily determine the cross-section of yields, whereas four volatility factors solely determine risk premia. The model is estimated using nominal Treasury yields, survey inflation forecasts, and inflation swap rates and has attractive empirical properties. Time-varying volatility is particularly apparent in shortterm real rates and expected inflation. Also, we detail the different economic forces that drive short-and long-term real and inflation risk premia and provide evidence that Treasury inflation-protected securities were undervalued prior to 2004 and during the recent financial crisis.]

We develop a model of nominal and real bond yield curves that has four stochastic drivers but seven factors: three factors primarily determine the cross-section of yields, whereas four volatility factors solely determine risk premia. The model is estimated using nominal Treasury yields, survey inflation forecasts, and inflation swap rates and has attractive empirical properties. Time-varying volatility is particularly apparent in short-term real rates and expected inflation. Also, we detail the different economic forces that drive short- and long-term real and inflation risk premia and provide evidence that Treasury inflation-protected securities were undervalued prior to 2004 and during the recent financial crisis.