Slope Of Term Structure Research Articles

Liquidity and Credit Risk

We develop a structural bond valuation model to simultaneously capture liquidity and credit risk. Our model implies that renegotiation in financial distress is influenced by the illiquidity of the market for distressed debt. As default becomes more likely, the components of bond yield spreads attributable to illiquidity increase. When we consider finite maturity debt, we find decreasing and convex term structures of liquidity spreads. Using bond price data spanning 15 years, we find evidence of a positive correlation between the illiquidity and default components of yield spreads as well as support for downward sloping term structures of liquidity spreads.

Yield Spread and Term to Maturity: Default vs. Liquidity

The aim of this paper is the analysis of the yield spreads between Treasury and non–Treasury Spanish fixed income assets and its relationship with the term to maturity. We find a downward sloping term structure of yield spreads for investment–grade bonds that seems to be contrary to the ‘crisis at maturity’ theory. However, we claim that this outcome is caused mainly by the effect of liquidity on yield spreads. Once the effect of liquidity and other factors are removed we find that there is a positive relationship between default premiums and term to maturity. That result is now consistent with the existing literature.

A factor model of term structure slopes in Eurocurrency markets

Recent empirical work has documented the existence of specific information in the slope of the term structure which is relevant to forecast future changes in economic activity. A good forecasting model of term structure slopes could therefore be helpful to anticipate changes in economic activity with an even longer anticipation. Firstly, it is analysed whether a good forecasting model can be found for term structure slopes in different currencies. After that, a factor model is constructed of term structure slopes, and the quality of slope forecasts obtained from factor models are compared to those obtained from univariate models.

Yield Spread and Term to Maturity: Default vs. Liquidity

The aim of this paper is the analysis of the yield spreads between Treasury and non-Treasury Spanish fixed income assets and its relationship with the term to maturity. We find a downward sloping term structure of yield spreads for investment-grade bonds that seem to be contrary to the crisis at maturity theory. However, we claim that this outcome is caused mainly by the effect of liquidity on yield spreads. Once the effect of liquidity and other factors are removed we find that there is a positive relationship between default premiums and term to maturity. That result is now consistent with the existing literature.

Junp‐Diffusion Interest Rate Process: An Empirical Examination

We investigate a jump‐diffusion process, which is a mixture of an O‐U process used by Vasicek (1977) and a compound Poisson jump process, for the term structure of interest rates. We develop a methodology for estimating the jump‐diffusion model and complete an empirical study in comparing the model with the Vasicek model, for the US money market interest rates. The results show that when the short‐term interest rate is low, both models predict an upward sloping term structure, with the jump‐diffusion model fitting the actual term structure quite well and the Vasicek model overestimating significantly. When the short‐term interest rate is high, both models predict a downward sloping term structure, with the jump‐diffusion model underestimating the actual term structure more significantly than the Vasicek model.

A Multifactor, Nonlinear, Continuous-Time Model of Interest Rate Volatility

This paper presents a general, nonlinear version of existing multifactor models, such as Longstaff and Schwartz (1992). The novel aspect of our approach is that rather than choosing the model parameterization out of thin air,' our processes are generated from the data using approximation methods for multifactor continuous-time Markov processes. In applying this technique to the short- and long-end of the term structure for a general two-factor diffusion process for interest rates, a major finding is that the volatility of interest rates is increasing in the level of interest rates only for sharply upward sloping term structures. In fact, the slope of the term structure plays a larger role in determining the magnitude of the diffusion coefficient. As an application, we analyze the model's implications for the term structure of term premiums.

Mispricing of Discount Bond Options in the Black-Derman-Toy Model Calibrated to Term Structure and Cap Volatilities: An Empirical Study

The Black-Derman-Toy short rate model, calibrated to a downward sloping initial term structure of volatilities, incorporates mean reversion by having future short rate volatilities decay with time. This would have a decaying effect on future term structure of volatilities and option prices on discount bonds as well. This effect is empirically examined by comparing discount bond option prices from the BDT tree to that from a HJM lognormal forward rate model fitted with the same initial volatilities. In this case, the BDT tree is found to price options with maturity up to six months within one or two percent of the accurate values. But it severely underprices longer maturity options, with the degree of underpricing increasing sharply with option maturity. The magnitude of underpricing turns out to be independent of discount bond maturities. When the BDT tree is calibrated using six-monthly cap prices, options of all maturities on six-month discount bonds are priced correctly, but options of all maturities on longer maturity bonds are overpriced. This overpricing is found to be independent of option maturities.

Pricing Mortgage-Backed Securities in a Multifactor Interest Rate Environment: A Multivariate Density Estimation Approach

Multivariate density estimation (MDE) suggests that mortgage-backed security (MBS) prices can be well described as a function of the level and slope of the term structure. We analyze bow this function varies across MBSs with different coupons. An important finding is that the interest rate level proxies for the moneyness of the option, the expected level of prepayments, and the average life of the cash flows, while the term structure slope controls for the average rate at which these cash flows should be discounted. Though the origination and prepayment behavior of mortgages differ substantially across coupons, there remains an unexplained common factor in MBS prices. This factor does not seem to be related to the usual suspects and therefore presents a puzzle to financial economists. Coauthors are Robert F. Whitelaw, Matthew Richardson, and Richard Stanton. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Nonlinearities in the Relation Between the Equity Risk Premium and the Term Structure

This paper investigates the relation between the conditional expected equity risk premium and the slope of the term structure of interest rates. Theoretically, these variables are linked, the relation may be nonlinear, and negative risk premiums are consistent with equilibrium. Given these implications, we employ a nonparametric estimation technique to document the empirical relation between the risk premium and the slope of the term structure using almost two hundred years of data. Of particular interest, the risk premium is increasing in the term structure slope; however, for either small or negative slopes, the risk premium is much more sensitive to changes in interest rates. In addition, the empirical results imply negative expected equity risk premiums for some inverted term structures. Finally, variations in the risk premium do not appear to be related to variations in the variance of equity returns. We illustrate these features in a stylized consumption-based model, and provide the economic intuition behind the results.

An Indicator of Future Inflation Extracted from the Steepness of the Interest Rate Yield Curve Along Its Entire Length

The term-structure slope contains information about expected future inflation. Mishkin shows that the spread between the twelve-month and three-month interest rates helps predict the difference between twelve-month and three-month inflation. We apply a simple existing framework, which lets the real interest rate vary in the short run but converge to a constant in the long run, to this problem. The appropriate indicator of expected inflation uses the entire length of the yield curve, estimating the steepness of a specific nonlinear transformation, rather than being restricted to a spread between two points. The resulting indicator better predicts inflation, over 1960–1991.

A multi-country study of the information in the shorter maturity term structure about future inflation

Empirical analysis of data from ten OECD countries indicates that, except for France, the United Kingdom, and Germany, the shorter maturity term structure does not contain a great deal of information about the future path of inflation. On the other hand, except for the United Kingdom there is a great deal of information in the term structure of nominal interest rates at shorter maturities about the term structure of real interest rates. These results are explained by differences in the relative variability of expected future inflation changes and real term structure slopes for the different countries.

What does the term structure tell us about future inflation?

This empirical analysis indicates that for maturities of six months or less, the term structure of nominal interest rates provides almost no information about the future path of inflation but does provide information about the term structure of real interest rates. However, as maturities lengthen to nine and twelve months, the nominal term structure begins to contain information about future inflation, but ceases to provide information about the real term structure. These results are explained by differences in the relative variability of expected future inflation changes and real term structure slopes at different points in the term structure.

Standardizing Yields on Mortgages and other Securities

The existence of a difference between the yield to maturity of a coupon bond and the expected holding period return on a coupon bond, referred to as coupon bias, is well recognized. This paper discusses the nature of coupon bias for mortgages, estimates the magnitude of the bias under different assumptions about the characteristics of the mortgage security and the term structure, and compares the magnitude of the coupon biases on mortgages and comparable coupon bonds. For a moderately upward sloping term structure at current levels of interest rates, coupon bias for a thirty‐year mortgage can be on the order of 75 basis points.