Nominal Yield Curve Research Articles

Dominant Currency Debt

We propose a to explain the international role of the dollar and provide broad empirical support for it. Within a simple capital structure model in which firms optimally choose the currency composition of their debt, we derive conditions under which all firms issue debt in a single, dominant currency. Theoretically, it is the currency that (1) depreciates in global downturns over horizons of typical debt maturity of firms and (2) has the steepest nominal yield curve. Both forward-looking and historical measures suggest that the dollar fits this description better than all major currencies. The debt view can jointly explain the fall and the rise of the dollar in international debt markets over the last two decades. It also offers insights into the future of the dominance of the dollar in the aftermath of the Covid-19 crisis.

A hybrid spline-based parametric model for the yield curve

Empirical evidence indicates that both nominal and real yield curves in important markets have segmentation between their short end and their longer-maturity segments. This segmentation might affect term structure estimation, introducing distortions in longer-maturity yields, especially in parametric models. In order to deal with such segmentation, we propose a new model that combines the flexibility of spline functions with the parsimoniousness of a parametric four-factor exponential model. The short end of the yield curve is fitted using a B-spline function, while longer segments are captured by the parametric model. We illustrate the benefits of the proposed model for pricing and risk management purposes, using two examples: the real yield curve in the Brazilian government index-linked bond market, and the US Treasury nominal yield curve. We show that, in both markets, our model is simultaneously able to fit the yield curve well and to provide unbiased Value at Risk estimates for all tested portfolios of bonds, outperforming an important parametric benchmark model frequently adopted by central banks.

The Natural Rate of Interest and Bond Returns

A growing literature argues that slower output growth is one of the main contributing factors to the fall in the natural rate of interest. Consistent with this evidence, we show empirically that real GDP growth is a major driver of the nominal yield curve. Specifically, the rate of economic growth constitutes a macroeconomic anchor that characterizes the path of the real short rate and influences the expectations hypothesis component embedded in bond yields. As a result, including growth data in canonical yield-curve models delivers significant gains in the predictability of bond excess returns in the United States and seven other developed economies.

QE in the Fiscal Theory: A Risk-Based View

This paper explores the interactions between yield curve dynamics and nominal government debt maturity operations under fiscal stress in a New Keynesian model with endogenous bond risk premia. Open market debt maturity operations are non-neutral when the slope of the nominal yield curve is nonzero in a fiscally-led policy regime. When the risk profiles of government liabilities differ, rebalancing the maturity structure changes the government cost of capital. In the fiscal theory, changes in discount rates affect inflation through the intertemporal government budget equation. When the yield curve is upward-sloping (downward-sloping), the fiscal discount rate channel implies that shortening the maturity structure dampens (amplifies) the stimulative effects of quantitative easing policies.

Mortgages and Monetary Policy

Mortgages are long-term nominal loans. Under incomplete asset markets, monetary policy is shown to affect housing investment and the economy through the cost of new mortgage borrowing and the value of payments on outstanding debt. These channels, distinct from traditional transmission of monetary policy, are evaluated within a general equilibrium model. Persistent monetary policy shocks, resembling the level factor in the nominal yield curve, have larger effects than transitory shocks, manifesting themselves as long-short spread. The transmission is stronger under adjustable- than fixed-rate mortgages. Higher, persistent, inflation benefits homeowners under FRMs, but hurts them under ARMs.

Functional Autoregression for Sparsely Sampled Data

We develop a hierarchical Gaussian process model for forecasting and inference of functional time series data. Unlike existing methods, our approach is especially suited for sparsely or irregularly sampled curves and for curves sampled with nonnegligible measurement error. The latent process is dynamically modeled as a functional autoregression (FAR) with Gaussian process innovations. We propose a fully nonparametric dynamic functional factor model for the dynamic innovation process, with broader applicability and improved computational efficiency over standard Gaussian process models. We prove finite-sample forecasting and interpolation optimality properties of the proposed model, which remain valid with the Gaussian assumption relaxed. An efficient Gibbs sampling algorithm is developed for estimation, inference, and forecasting, with extensions for FAR(p) models with model averaging over the lag p. Extensive simulations demonstrate substantial improvements in forecasting performance and recovery of the autoregressive surface over competing methods, especially under sparse designs. We apply the proposed methods to forecast nominal and real yield curves using daily U.S. data. Real yields are observed more sparsely than nominal yields, yet the proposed methods are highly competitive in both settings. Supplementary materials, including R code and the yield curve data, are available online.

A Hybrid Spline-Based Parametric Model for the Real Yield Curve

Empirical evidence indicates that both nominal and real yield curves in important markets have segmentation between their short end and their longer-maturity segments. This segmentation might affect term structure estimation, introducing distortions in longer-maturity yields, especially in parametric models. In order to deal with such segmentation, we propose a new model that combines the flexibility of spline functions with the parsimoniousness of a parametric four-factor exponential model. The short end of the yield curve is fitted using a B-spline function, while longer segments are captured by the parametric model. We illustrate the benefits of the proposed model for pricing and risk management purposes, using two examples: the real yield curve in the Brazilian government index-linked bond market, and the US Treasury nominal yield curve. We show that, in both markets, our model is simultaneously able to fit the yield curve well and to provide unbiased Value at Risk estimates for all tested portfolios of bonds, outperforming an important parametric benchmark model frequently adopted by central banks.

Menová politika záporných úrokových sadzieb v eurozóne a Japonsku

Since 2014, European Central Bank and Bank of Japan have entered into the unchartered water of modest negative nominal interest rates, when they broke zero lower bound. Large-scale asset purchases and forward guidance effects are limited by zero nominal bound if yield curve is absolutely flat. Negative interest rate has been implemented with the aim of reinforcing effects of unconventional monetary policy and lowering real interest rates. Therefore, another decrease in nominal yield curve should ensure, that inflation target will be met in a medium term horizon. Main goal of the paper is to reveal implementation, transmission channels and risks associated with the negative interest rates. Implementation was successful within the existing framework of the current monetary policy. Negative effective interest rate has been reflected in sharp drop of governments yield curve and mortgage rates. According current constellation of negative interest rates, monetary effect outperforms potential unintended impacts. On the other side, there are many risks mainly for financial stability and financial market functioning, if negative interest rates will be under effective zero lower bound or will persists for an extended period.

The expected real yield and inflation components of the nominal yield curve

The term structure of real yields and expected inflation are two unobserved components of the nominal yield curve. The primary objectives of this study are to decompose nominal yields into their expected real yield and inflation components and to examine their behaviour using state-space and regime-switching frameworks. The dynamic yield-curve models capture three well-known latent factors – level, slope, and curvature – that accurately aggregate the information for the nominal yields and the expected real and inflation components for all maturities. The nominal yield curve is found to increase slightly with a slope of about 120 basis points, while the real yield curve slopes upward by about 20 basis points, and the expected inflation curve is virtually flat at slightly above 2 per cent. The regime-switching estimations reveal that the nominal yield, real yield and expected inflation curves have shifted down significantly since 1999.

Decomposing real and nominal yield curves

Inflation-indexed and nominal yield curves capture investors׳ expectations of real short rates and inflation as well as their required compensation for bearing liquidity, inflation, and real interest rate risk. We estimate an affine term structure model that allows us to decompose real and nominal bond yields into these components and use the model to study the transmission of monetary policy. The model decompositions imply that the Federal Reserve׳s announcements of LSAPs lowered yields primarily by reducing real term premia. Changes in real term premia also account for the strong response of long-term real forward rates to federal funds rate surprises.

Implicit Inflation and Risk Premiums in the Brazilian Fixed Income Market

ABSTRACTThe breakeven inflation, the differential between nominal and real yields of bonds, is often used as a predictor of future inflation. The model presented here decomposes this interest rate differential into a risk premium and implicit inflation using a parametric formulation based on no-arbitrage conditions using nominal and indexed yield curves in Brazil, via an affine model of the Nelson–Siegel family. The measures of implicit inflation obtained from the model are shown to be unbiased estimators of future inflation for short horizons and carry some information for long horizons, and the model forecasts are superior to market surveys.

Real and Nominal Equilibrium Yield Curves: Wage Rigidities and Permanent Shocks

The links between real and nominal bond risk premia and macroeconomic dynamics are explored quantitatively in a model with nominal rigidities and monetary policy. The estimated model captures macroeconomic and yield curve properties of the U.S. economy, implying significantly positive real term and inflation risk bond premia. In contrast to previous literature, both premia are positive and generated by wage rigidities as a compensation for permanent productivity shocks. Stronger policy-rule responses to inflation (output) increase (decrease) both premia, while policy surprises generate negligible risk premia. Empirical evidence of the economic mechanism is provided.

Nominal term structure and term premia: evidence from Chile

ABSTRACTThe downwards trend exhibited in Chile’s nominal term structure since 2003 has been a common pattern shared by other developed and developing economies. To understand the behaviour of the nominal yield curve in Chile, we rely on an affine dynamic term structure model which allows the term structure to decompose into the expected short-term interest rate (related to the monetary policy expectation) and the term premium. We show that most of the fall of long-term interest rates as well as its dynamics are related to the term premium rather than the expected short-term interest rate. Moreover, we find evidence that term premium is driven primarily by the US term premium and domestic nominal uncertainty derived from expected inflation.

Inflation forecasts extracted from nominal and real yield curves

Abstract The aim of this paper is to evaluate the performance of inflation forecasts backed out from the nominal and real yield curves in the United Kingdom. We use the Nelson–Siegel (NS) framework to model the break-even inflation term structure, and we base our analysis on the one-day break-even inflation derived from NS factors, which avoids the need for a direct estimation of the inflation risk premium. Fitting (vector) autoregression models augmented with nominal and/or real Cochrane-Piazzesi factors, we find that parsimonious models based on the one-day break-even inflation outperform other models in forecasting inflation out-of-sample. In addition, we quantify the parameter uncertainty and show that it may have considerable impact on inflation forecasts.

Scarce Collateral, the Term Premium, and Quantitative Easing

A model of money, credit, and banking is constructed in which the differential pledgeability of collateral and the scarcity of collateralizable wealth lead to a term premium — an upward-sloping nominal yield curve. Purchases of long-maturity government debt by the central bank are always a good idea, but for unconventional reasons. A floor system is preferred to a channel system, as a floor system permits welfare-improving asset purchases by the central bank.

Scarce collateral, the term premium, and quantitative easing

A model of money, credit, and banking is constructed in which the differential pledgeability of collateral and the scarcity of collateralizable wealth lead to a term premium – an upward-sloping nominal yield curve. Purchases of long-maturity government debt by the central bank are always a good idea, but for unconventional reasons. A floor system is preferred to a channel system, as a floor system permits welfare-improving asset purchases by the central bank.

Real and Nominal Equilibrium Yield Curves with Endogenous Inflation: A Quantitative Assessment

The links between real and nominal bond risk premia and macroeconomic dynamics are explored analytically and quantitatively in a model with nominal rigidities and monetary policy. The interest-rate policy rule becomes a restriction linking real and nominal risk premia through endogenous inflation. The estimated model captures macroeconomic and yield curve properties of the U.S. economy, implying significantly positive real term and inflation risk bond premia. Both premia are induced by wage rigidities as a compensation for permanent productivity shocks. Stronger policy-rule responses to inflation (output) increase (decrease) both premia. Policy surprises generate significant yield volatility but negligible risk premia.

Mortgages and Monetary Policy

Mortgages are long-term nominal loans. Under incomplete asset markets, monetary policy is shown to affect housing investment and the economy through the cost of new mortgage borrowing and the value of payments on outstanding debt. These channels, distinct from traditional transmission of monetary policy, are evaluated within a general equilibrium model. Persistent monetary policy shocks, resembling the level factor in the nominal yield curve, have larger effects than transitory shocks, manifesting themselves as long-short spread. The transmission is stronger under adjustable- than fixed-rate mortgages. Higher, persistent, inflation benefits homeowners under FRMs, but hurts them under ARMs.

A Portfolio-Balance Approach to the Nominal Term Structure

I examine how the maturity structure of outstanding government li- abilities aects the nominal yield curve under a variety of assumptions about investor objectives. In the class of models I consider, equilib- ria are arbitrage free, expectations are rational, and assets are valued only for their pecuniary returns. Nonetheless, a portfolio-balance mech- anism arises through the dependence of the pricing kernel on the return on wealth. This mechanism results in a positive relationship between the duration of bondholders'portfolios and the price of interest-rate risk. Quantitatively, the models suggest that the eects of shifting Treasury supply on yields can be substantial— for example, the increase in the av- erage maturity of U.S. government debt that occurred between 1976 and 1988 may have raised the ten-year yield by 50 basis points. On the other hand, partly re‡ecting an attenuation of portfolio-balance eects when in- terest rates are near zero, the Federal Reserve's asset purchase programs likely had a fairly small impact on the yield curve by removing duration from the market.

Estimating inflation compensation for Turkey using yield curves

Inflation compensation derived from nominal and real bond yields contains market based, real time information regarding the inflation expectations and the pricing of inflation risks. In this study, we calculate inflation compensation for Turkey by using nominal and real yield curves. The findings of event study analysis on inflation compensation indicate that changes in the term structure of inflation compensation contain information regarding the credibility of monetary authority. Moreover, we find that, at daily frequency, liquidity conditions have no significant effect on inflation compensation and hence the effects of events such as monetary policy decisions and inflation surprises on inflation compensation can be attributed mainly to changes in inflation expectations and pricing of inflation uncertainty.