Adaptive dynamic Nelson–Siegel term structure model with applications

Recent events have highlighted the potential importance of nonlinear efiects of flscal variables (notably debt and deflcits) on interest rates: While in times when government solvency is not a concern the standard crowding-out efiects are of moderate magnitude, in times when default risk becomes an issue the interest rate efiects can become very large. This paper provides new evidence on the magnitude of these efiects. For the case when default risk is not a concern, it uses an arbitrage-free term structure model to estimate the dynamic efiects of flscal policy shocks on interest rates along the entire maturity spectrum. For the case when default risk becomes a concern (thereby violating a central assumption of the term structure model), I present evidence based on EMU government bond spread regressions on time-varying efiects of national flscal policies on spreads as well as the time-varying sensitivity of yield spreads to international risk aversion as a function of the state of flscal policy. JEL classiflcation: E6, H6.

Dai and Singleton (2002) and Duffee (2002) show that there is a tension in affine term structure models between matching the mean and the volatility of interest rates. This article examines whether this tension can be solved by an alternative parametrization of the price of risk. The empirical evidence suggests that, first, the examined parametrization is not sufficient to solve the mean-volatility tension. Second, the usual result in the estimation of affine models, indicating that some of the state variables are extremely persistent, may have been caused by the lack of flexibility in the parametrization of the price of risk. Term structure models have several uses, including pricing fixed-income derivatives, managing the risk of fixed-income portfolios, and detecting relationships between the term structure of interest rates and macrovariables such as inflation and consumption. To perform well in these tasks, term structure models must be numerically and econometrically tractable while matching the empirical properties of the term structure movements. At least two empirical properties of the term structure of interest rates have been well established by financial economists over the years [see Dai and Singleton (2003) for a survey]. First, the term premium, or the expected excess return of Treasury bonds, has a high time variability. Second, the volatility of interest rates is time varying. These two properties are so prominent in the data that they will be referred to as stylized facts. While these two stylized facts are very well established in the empirical literature, affine term structure models are thoroughly discussed in the theoretical literature. Affine models are those in which the yield of zero coupon bonds are affine functions of the model state variables. Classic

In econometric applications of the term structure, affine models are among the most used ones. Nevertheless, even presenting a closed form characteristic function, its estimation procedure still presents many points to be understood and difficulties to be removed. In this note, we address one of these points. Suppose we estimate an affine dynamic term structure model, and also apply principal component analysis to the interest rate database available. A very plausible question would inquire about the relation (if any) between the principal components obtained assuming no dynamic restrictions, and the dynamic factors estimated using the proposed term structure model. We answer this question when estimating a standard affine model using zero coupon data. We show that each principal component can be approximated by a linear transformation of the dynamic factors. Although simple, this is an important step to the understanding of the mechanics of dynamic affine term structure models. A numerical example using U.S. zero data illustrates the result

This paper provides cross-country empirical evidence on term premia. I construct a panel of zero-coupon nominal government bond yields spanning ten industrialized countries and nearly two decades. I hence compute forward rates and use two different methods to decompose these forward rates into expected future short-term interest rates and term premiums. The first method uses an affine term structure model with macroeconomic variables as unspanned risk factors; the second method uses surveys. I find that term premiums declined internationally over the sample period, especially in countries that apparently reduced inflation uncertainty by making substantial changes in their monetary policy frameworks. (JEL E13, E43, E52, G12, H63)

An affine term structure model with Fed chairs’ speeches

This paper develops a method to approximate arbitrage-free bond yields within a term structure model in which the short rate follows a Gaussian process censored at zero (a shadow-rate model as proposed by Black, 1995). The censoring ensures that model-implied yields are constrained to be positive, but it also introduces non-linearity that renders standard bond pricing formulas inapplicable. In particular, yields are not linear functions of the underlying state vector as they are in affine term structure models (see Piazzesi, 2010). Existing approaches towards computing yields in shadow-rate models suffer from high computational burden or low accuracy. In contrast, I show that the technique proposed in this paper is sufficiently fast for single-step estimation of a three-factor shadow-rate term structure model, and sufficiently accurate to evaluate yields to within approximately half a basis point.

Invariance, observational equivalence, and identification: Some implications for the empirical performance of affine term structure models

This paper provides a comparative evaluation of the behaviour of long-term sovereign yields in Czechia, Hungary and Poland from 2001 to 2019. An affine term structure model developed by Adrian, Crump and Moench (2013) is used as an empirical framework for the decomposition of the bond yields into term premium and risk-neutral components. We document a substantial compression in term premia which started in Central European economies around 2013 and played a decisive role in the changes that occurred in 10-year sovereign yields. This pattern, however, was more prevalent in Czechia and Poland than in Hungary. We show that long-term rates in all three economies remained higher than in Germany due to relatively large risk-neutral components. Nevertheless, cross-country correlations became increasingly dependent on term premium dynamics, both among Central European economies and between each of them and Germany. These results are robust to bias-correction in the baseline models and interpreted in the light of the general interest rates decline in the global economy. Potential policy implications are also discussed.

This paper provides cross-country empirical evidence on term premia. I construct a panel of zero-coupon nominal government bond yields spanning ten industrialized countries and nearly two decades. I hence compute forward rates and use two different methods to decompose these forward rates into expected future short-term interest rates and term premiums. The first method uses an affine term structure model with macroeconomic variables as unspanned risk factors; the second method uses surveys. I find that term premiums declined internationally over the sample period, especially in countries that apparently reduced inflation uncertainty by making substantial changes in their monetary policy frameworks. (JEL E13, E43, E52, G12, H63)

Yield Curve Reaction to Macroeconomic News in Europe: Disentangling the US Influence

SummaryUS yield curve dynamics are subject to time‐variation, but there is ambiguity about its precise form. This paper develops a vector autoregressive (VAR) model with time‐varying parameters and stochastic volatility, which treats the nature of parameter dynamics as unknown. Coefficients can evolve according to a random walk, a Markov switching process, observed predictors, or depend on a mixture of these. To decide which form is supported by the data and to carry out model selection, we adopt Bayesian shrinkage priors. Our framework is applied to model the US yield curve. We show that the model forecasts well, and focus on selected in‐sample features to analyze determinants of structural breaks in US yield curve dynamics.

Using the yield data for Korean government bonds, I examine several discrete-time affine term structure models with unspanned macro factors, such as output and inflation, and compares term premia implied from alternative models with different combinations of output and inflation variables. Empirical analysis shows that, except for 1-year maturity ones, there is little difference among the medium- to long-term term premia across alternative models. The model-implied term premium estimates do not show a significant pro- or counter-cyclicality in relation to output variables, but show a highly positive correlation with inflation variables. In addition, I test the traditional expectation hypothesis by fitting Campbell-Shiller long-rate regressions to the Korean bond data, the expectation hypothesis is strongly rejected as in the case of the US, due to time-varying term premia, and an additional Monte Carlo simulation study indicates that the term structure models considered in this paper show a success in matching the regression coefficients estimated from the sample.

This article combines a Structural Vector Autoregression with a no-arbitrage approach to build a multifactor Affine Term Structure Model (ATSM). The resulting No-Arbitrage Structural Vector Autoregressive (NASVAR) model implies that expected excess returns are driven by structural macroeconomic shocks. This is in contrast with a standard ATSM, in which agents are concerned with non-structural risks. As a simple application, we study the effects of supply, demand and monetary policy shocks on the UK yield curve. We show that all structural shocks affect the slope of the yield curve, with demand and supply shocks accounting for a large part of the time variation in bond yields.

Switching Monetary Policy Regimes and the Nominal Term Structure

The impact of crisis periods and monetary decisions of the Fed and the ECB on the sovereign yield curve network