Why are long term bonds subjected to a higher volatility, as well as higher yield than short term bonds?

Question

Why are long term bonds subjected to a higher volatility, as well as higher yield than short term bonds? (Assuming normal yield curve). Say, I have 2 investment options and my investment horizon is 2 years:

1. A 10-Year govt bond
2. A 2-Year govt bond

I can either hold a 10Y government bond for 2 years, then sell it in the market after 2 years, or hold the 2 year government bond until maturity.

Since we can decide our investment horizons regardless of the maturities of the bonds, why doesn't the ability to trade any time you want eliminate the difference of volatility and yield between a 2Y and a 10Y government bond?

Answer 1

The longer the time horizon, the greater the risk and the higher the volatility. There are many more dire economic and events that can occur in 10 years rather than 2 years. Specifically Interest rates, inflation, and other factors will cause the bonds interest rates to change, so longer duration events are consider more risky over a longer period of time than shorter duration bonds. So even though you are considering selling the 10 year bond in 2 years, it will ultimately have 8 more years to go, and that will raise the volatility since the remaining pricing will be unknown.

As far as comparing equivalent yields with duration bond: if a ten year note is currently yielding 2.87 and a 2 year note is yielding 2.83, you would get approximately .04 more yield for the 10 year note. Say, that you make your decision to sell in two years, on the day the 2 year note expires. That note expires and you will get roughly 2.83 Yield to maturity, but if bad economic news has been announced around that time (increased inflation, etc.), the 10 year note might be dropping in price a lot more than the have earned in yield, and you might have to sell at loss. So the returns are not equivalent.