Term Structure Of Rates Research Articles

A survey of dynamic Nelson-Siegel models, diffusion indexes, and big data methods for predicting interest rates

In this paper we survey a number of recent empirical findings regarding the usefulness of including diffusion indexes in dynamic Nelson-Siegel (DNS) type models used to predict the term structure of interest rates (see e.g., Diebold and Li (2007) and Diebold and Rudebusch (2013)). We also survey various empirical methods used in the construction of DNS models, and used to specify and estimate diffusion index augmented DNS models. In particular, we review (sparse) principal component analysis, factor augmented autoregression, and various dimension reduction, variable selection, machine learning, and shrinkage methods, such as the least absolute shrinkage operator (lasso), the elastic net, and independent component analysis, among others. Finally, we discuss the importance of using real-time data in contexts where datasets are subject to revision; and we compare and contrast the use of targeted versus un-targeted specification methods when including diffusion indexes in DNS type prediction models. Interestingly, as noted in Swanson and Xiong (2018a, 2018b), the usefulness of diffusion indexes is crucially dependent upon whether real-time data are used or not. Specifically, when real-time data are used to estimate the weights in di usion indexes, it is found that relatively few “data rich” models that use big data are preferred to simpler DNS models, post 2010. Instead, pure DNS models that rely only on historical interest rate data deliver mean square error “best” forecasts. However, when data are not real-time, diffusion indexes always have marginal predictive content for interest rates. Moreover, it is clear that in more volatile interest rate regimes, such as prior to 2010, machine learning and related methods have much to offer, regardless of the type of dataset used in their construction.

KEYNES, PUBLIC DEBT, AND THE COMPLEX OF INTEREST RATES

John Maynard Keynes consistently offered qualified endorsement of Abba Lerner’s “functional finance” doctrine—the qualifications particularly turning on Keynes’s attentiveness to policy management of the psychology of the debt market. This article examines Keynes’s understanding of the possible influence of public debt on interest rates, from 1930 forward. With the multiplier a mechanism whereby debt-financed public investment generates matching private saving (net of private investment) plus public saving, it becomes possible for Keynes to conclude that increasing public debt need not place upward pressure on the level of interest rates, so long as policy can successfully manage the psychology of the debt market. This particularly concerns long interest rates and hence the term structure of rates. His theory of the term structure enables Keynes’s conviction that policy can manage and shape long rates. The conclusion considers also whether Keynes’s caution concerning public debt and interest rates retains relevance today.

The term structure of interest rates with housing

Abstract This paper develops a general equilibrium model to study the link between the amount of capital invested in housing assets and the term structure of interest rates. In the model, the production of housing assets is irreversible and housing assets can be used as collateral for borrowing funds. Agents’ decisions about consumption and investments in housing and non-housing assets generate a time-varying market price of risk that drives the dynamics of the term structure. The calibration to U.S. data using the simulated method of moments technique captures the dynamics of consumption, and the short- and long-term interest rates.

The Influence of Stephen A. Ross: Reflections of an Empirical Finance Economist

This article describes the influence of Stephen A. Ross on research and practice in empirical asset pricing. Written by a doctoral student of Professor Ross, this article reviews his work on arbitrage pricing theory, the discounting of risky cash flows, option pricing, the term structure of interest rates, and the relationship between financial econometrics and portfolio analysis.

Duration, Convexity and the Optimal Management 0f Bond Portfolios for Insurance Companies

Two Fong-Vasicek immunization results are discussed and applied in relation to asset portfolios of a sample of Italian insurance companies managing life insurance with-profit savings. Firstly, we analyzed the contribution of Fong and Vasicek (1984) providing a lower bound on the “shortfall” of an asset portfolio, managed with a duration-matching target, in the face of an arbitrary shock to the term structure of interest rates. A “passive” management strategy emerges, aimed at minimizing risk, such that the exposure to an arbitrary variation of the shape of the term structure is minimized with respect to a risk measure that is increasing with the cash-flows dispersion. Secondly, Fong and Vasicek (1983) approach is generalized, in line with the classical risk-return approach to portfolio management, in a model which overturns the “passive” perspective of minimum risk exposure and looks for only a partial risk minimization in exchange for more return potential. The empirical application shows that such a perspective may be proved useful to highlight which segregated funds can be re-positioned over the efficient frontier, at the chosen level of the firm’s risk appetite.

A Consumption Based Term Structure Model w ith Habit Utility

This paper proposes a term structure of interest rates model that modifies and extends the Campbell and Cochrane (1999) surplus consumption framework. The distinguishing contributions are tractable, continuous-time analytical solutions for the term structure of interest rate generating a realistic upward sloping yield curve. Despite the focus on the term structure, the model matches plausible equity quantities. For the interest rate, the model is able to account for the moments of bond yields at numerous maturities and produce countercyclical bond risk premia as seen in the data. Moreover, the model captures reasonable time series fluctuation on real interest rates. However, the model has difficulties reproducing empirical deviations from the expectations hypothesis.

The expectations hypothesis of the term structure of interest rates: The Brazilian case revisited

ABSTRACTThis article tests the Expectations Hypothesis (EH) using Brazilian monthly data for bond yields spanning the 2000–2017 sample period and ranging in maturity from 3 months to 5 years. Three tests are examined: the first is based on interest rates spread and the other two are based on the forward rates. On balance our results suggest rejection of the EH throughout the maturity spectrum examined, and are broadly consistent with previous findings that a linear combination of forward rates provides a statistically significant prediction of bond excess returns.

Optimal management of immunized portfolios

We generalize the contribution of Fong and Vasicek (Financ Anal J 39:73–78, 1983a; Innov Bond Portf Manag Durat Analy Immun 1983:227–238, 1983b; J Financ 39:1541–1546, 1984) by developing a risk-return optimization problem for immunized life insurance portfolios. The M2 measure of risk for arbitrary changes of the term structure of interest rates is used for a bond portfolio with duration matched to a given liability horizon. The immunization case becomes a “passive” strategy among an entire menu of active management decisions in which a partial risk minimization is exchanged for more return potential. As in the classical Markowitz (Portfolio Selection, New York, Wiley, 1959) approach, an efficient frontier at the given horizon provides the optimal tradeoff between risk and return. An empirical application to insurance companies shows that such a perspective may be proved useful to highlight which segregated funds can be re-positioned over the efficient frontier, at the chosen level of the firm’s risk appetite.

The Leverage Anomaly in U.S. Bank Stock Returns

The relationship between leverage and returns on US bank stocks between 1973 and 2019 is slightly hump-shaped, almost flat. This observed relationship cannot be explained by standard risk factors such as correlation with the market return, book-to-market, size, momentum and term structure of interest rates. As a result, risk-adjusted returns (alphas) of highly leveraged banks are negative. Moreover, the stock returns exhibit a delayed reaction to changes in leverage. Highly leveraged banks that further increase their debt have high abnormal returns on the day of announcement, but tend to have low risk-adjusted returns during the following 6 months. This paper uncovers several explanations for this leverage anomaly. First, investors seem to underestimate the negative effect of leverage on future asset growth. Next, under-priced default risk, under-priced systematic risk and sensitivity to idiosyncratic volatility are prominent features of bank stock returns.

The quantum field model for treasury forward interest rate

With the further reform of interest rate liberalization and the increasing of interest rate derivatives, it becomes more important and urgent to model the forward rate accurately and rationally in China. In this paper, we use the quantum field theory in econophysics, which can effectively incorporate the incomplete correlations between forward interest rates with different maturities, to model the Chinese treasury bond instantaneous forward rates. Firstly, we start with the correlation structure of the instantaneous change of treasury forward rates, one of the most important variables for a quantum field, during the period from January 4, 2011 to December 30, 2016, then apply the quantum field theory to model the actual market evolution of the treasury instantaneous forward rates directly. Secondly, we also use the mainstream two-factor Heath-Jarrow-Morton (HJM) model commonly used in financial industry, which requires the particular form of forward rate volatility functions to be set in advance, to model the treasury instantaneous forward rates, then compare the results with those of the quantum field model. The empirical results show that the quantum field model based on stiff action provides a fitting accuracy of 63.23% for actual treasury bond instantaneous forward rate, but this fitting accuracy increases to 92.67% for the quantum field model with taking into account the psychological perceptive remaining time, which is also superior to the classic optimal two-factor HJM model with a fitting accuracy of 69.02%. Finally, the optimal parameters estimated are respectively substituted into the forward interest rate update equations of the quantum field model with the psychological perception time in mind and the classical two-factor HJM model to conduct the back testing of forward rates with one hundred maturities, from January 3, 2017 to December 30, 2017. From the results of average instantaneous forward rate, root mean square error and Theil inequality coefficient, we can see the superiority of using the quantum field theory to model the term structure of treasury forward rates compared with traditionally used two-factor HJM model in financial industry. In conclusion, the quantum field model we constructed, is more consistent with the actual situation, and all the parameters estimated by this model are obtained directly from the market data, without making any assumption of the specific form of forward rate volatility function, thus greatly improving the accuracy of applying the quantum field theory to finance. These findings are not only of great theoretic and practical significance for applying the quantum field theory to pricing those financial products linked to treasury bonds and for managing its relevant interest rate risk, but also have reference value for quantitatively analyzing banks and finance companies in financial field, and also for practitioners in the field of fixed-income securities.

Evolving fuzzy modelling for yield curve forecasting

Forecasting the term structure of interest rates plays a crucial role in portfolio management, household finance decisions, business investment planning, and policy formulation. This paper aims to address yield curve forecasting and evolving fuzzy systems modelling using data from US and Brazilian fixed income markets. Evolving fuzzy models provide a high level of system adaptation and learn the system dynamic continuously, which is essential for uncertain environments as interest rate markets. Computational experiments show that the evolving fuzzy modelling approaches describe the interest rate behaviour accurately, outperforming traditional econometric techniques in terms of error measures and statistical tests. Moreover, evolving models provide promising results for short and long-term maturities and for both fixed income markets evaluated, highlighting its potential to forecast complex nonlinear dynamics in uncertain environments.

Foreign Reserves of Emerging Market Economies, Bond Free-Float and the Nominal Term Structure of German Interest Rates

Foreign Reserves of Emerging Market Economies, Bond Free-Float and the Nominal Term Structure of German Interest Rates

Optimal Term Structure in a Monetary Economy with Incomplete Markets

AbstractIn a stochastic economy, the rebalancing of short and long term government debt positions can have real effects when markets are incomplete. This paper analyzes both stationary and dynamic policy rules for the term structure of interest rates. After proving the existence of a recursive representation of equilibrium, necessary conditions for Pareto efficiency are characterized. The necessary conditions are equivalent for both stationary and dynamic policy rules.

Property-Speciic Factors and the Term Structure of Commercial OOce Rents in Central London

I explore the effect of latent property characteristics on the estimation of the term structure of lease rates. Using data on Central London office leases, OLS specifications yield estimates of a significantly positive term structure, which is consistent with similar regressions documented in the literature. However, the effect is confounded by heterogeneity at the property level. Aggregating leases without regard to these important property-specific factors results in a spurious term effect. Specifically, the age of the space is shown to correlate not only with the contract rent, but also with the lease term. Long leases in older properties command higher lease rates, consistent with premiums required to compensate landlords for encumbered redevelopment options.

The optimal trade-off between interest rate risk and annual return of bond ladders

Bond laddering is a popular fixed-income investment strategy. The main purpose of this paper is to develop a methodology for determining private investors’ most interest rate risk (IRR)-return-efficient investment horizon for bond ladders (BLs), which are virtually free of credit risk. Two IRR measures of a continuously rolling and homogenous BL (CRHBL) are analytically derived under the assumption that interest rates are martingales. The first measure is the modified duration, which assumes a flat term structure of interest rates. However, this assumption is not fully supported by the empirical data and, thus, an additional IRR measure is proposed. Under each of these two measures, the ratios between the annual return in excess of the demand deposit rate and IRR of CRHBLs with different investment horizons are calculated. As expected, CRHBLs with rather low IRR are most risk-return-efficient. The results for the theoretical CRHBLs also apply to “real-world” discrete BLs. Thus, the proposed methodology can help private investors construct IRR-return-efficient discrete BLs.

An analysis of arbitrage strategies in Chinese treasury bond market

The yield curve of the Treasury bonds has important economic implications. Its shape can reflect the expectation of the economy, and the corresponding trading strategy can be formulated by the characteristics of the change in the yield curve. In this paper, co-integration and principal component analysis (PCA) are used to study the term structure of interest rates in China. The three morphological features, level, slope and curvature are extracted. The empirical analysis shows that the level, slope and curvature factors can better describe the morphological characteristics of yield curves. The slope and curvature factor have good stationarity and mean reversion. The butterfly arbitrage strategy is designed by using curvature factor and a stable income can be obtained.

The Information Content of the Term Structure of Interest Rates in Emerging Economies: The Case of Thailand

This article studies the information content of the term structure of interest rates of Thai government bonds. Using monthly data from July 2001 to December 2013, this article tests whether the term structure contains information about future interest rates, inflation and gross domestic product (GDP) growth. The results suggest that, despite the low liquidity of the Thai government bond market, the term structure contains considerable information about future interest rates and GDP growth. JEL Classification: E43, E44, G12

Pronósticos de la estructura temporal de las tasas de interés en México con base en un modelo afín

Se muestra que un modelo afín permite igualar o mejorar los pronósticos de la estructura temporal de las tasas de interés en México. El modelo de pronóstico se especifica como una relación lineal entre las tasas de interés y tres factores observables, para vencimientos de 1-60 meses. Los pronósticos del modelo afín son comparados con estos de una tasa forward, un AR (1), un VAR (1) y una caminata aleatoria. El modelo afín tiene un desempeño comparable con los otros modelos para horizontes de 12- y 18- meses, con excepción de la caminata aleatoria, Que presenta menores pronósticos para los vencimientos de 24- y 36- meses. No obstante, el modelo afín mejora su desempeño de pronóstico para los horizontes de 24- meses, principalmente para vencimientos de 60-meses

A Revised Approach to CIR Short-Term Interest Rates Model

It is well known that the Cox-Ingersoll-Ross (CIR) stochastic model to study the term structure of interest rates, as introduced in 1985, is inadequate for modelling the current market environment with negative short interest rates. Moreover, the diffusion term in the rate dynamics goes to zero when short rates are small; both volatility and long-run mean do not change with time; they do not fit with the skewed (fat tails) distribution of the interest rates, etc. The aim of the present work is to suggest a new framework, which we call the CIR # model, that fits well the term structure of short interest rates such that the market volatility structure is preserved as well as the analytical tractability of the original CIR model.

Multi Yield Curve Stress-Testing Framework Incorporating Temporal and Cross Tenor Structural Dependencies

We develop a new multi-curve modelling framework for the term-structure of interest rates that can generate consistent cross-country stressed scenarios allowing for significant spillover effects between economies. Modern models of the term structure of interest rates typically fail to capture jointly time and cross-curve dependencies and are not used for stress-testing purposes. Our methodology is able to jointly model the temporal and cross-country dependence structure of interest rate curves and associate movements in the interest rates and cross-country spreads with movements in macroeconomic variables as well as market-wide and country-specific measures of liquidity and credit quality. We apply our methodology to generate contemporaneous stressed scenarios to a set of European yield curves. Motivated by the recent eurozone debt crisis, we apply shocks to Italian and Spanish liquidity and credit variables and evaluate the impact of these shocks on several bond portfolio strategies. The empirical findings suggest that both country-specific liquidity and credit measures are important in explaining the dynamic behaviour of European sovereign interest rate curves and their dependence structure. Nevertheless, their importance varies across time, shock types and investment horizons.