We derive the class of affine arbitrage-free dynamic term structure models that approximate the widely used Nelson–Siegel yield curve specification. These arbitrage-free Nelson–Siegel (AFNS) models ...can be expressed as slightly restricted versions of the canonical representation of the three-factor affine arbitrage-free model. Imposing the Nelson–Siegel structure on the canonical model greatly facilitates estimation and can improve predictive performance. In the future, AFNS models appear likely to be a useful workhorse representation for term structure research.
The demographic transition can affect the equilibrium real interest rate through three channels. An increase in longevity—or expectations thereof—puts downward pressure on the real interest rate, as ...agents build up their savings in anticipation of a longer retirement period. A reduction in the population growth rate has two counteracting effects. On the one hand, capital per-worker rises, thus inducing lower real interest rates through a reduction in the marginal product of capital. On the other hand, the decline in population growth eventually leads to a higher dependency ratio (the fraction of retirees to workers). Because retirees save less than workers, this compositional effect lowers the aggregate savings rate and pushes real rates up. We calibrate a tractable life-cycle model to capture salient features of the demographic transition in developed economies, and find that its overall effect is a reduction of the equilibrium interest rate by at least one and a half percentage points between 1990 and 2014. Demographic trends have important implications for the conduct of monetary policy, especially in light of the zero lower bound on nominal interest rates. Other policies can offset the negative effects of the demographic transition on real rates with different degrees of success.
This paper examines the joint determination of deviations in long-term covered interest rate parity and differences in the credit spread of bonds of similar risk but different currency denomination. ...These two pricing anomalies are highly aligned in both the time series and the cross-section of currencies. The sum of these two pricing deviations—the corporate basis—represents the currency-hedged borrowing cost difference between currency regions and explains up to a third of the variation in the aggregate corporate debt issuance flow. I show that arbitrage aimed at exploiting one type of security anomaly can give rise to the other.
The term structure of interbank risk Filipović, Damir; Trolle, Anders B.
Journal of financial economics,
09/2013, Volume:
109, Issue:
3
Journal Article
Peer reviewed
Open access
We infer a term structure of interbank risk from spreads between rates on interest rate swaps indexed to the London Interbank Offered Rate (LIBOR) and overnight indexed swaps. We develop a tractable ...model of interbank risk to decompose the term structure into default and non-default (liquidity) components. From August 2007 to January 2011, the fraction of total interbank risk due to default risk, on average, increases with maturity. At short maturities, the non-default component is important in the first half of the sample period and is correlated with measures of funding and market liquidity. The model also provides a framework for pricing, hedging, and risk management of interest rate swaps in the presence of significant basis risk.
We investigate 1-year interest rate swaps on USD, EUR, JPY and GBP between 2005 and 2020 utilising a quantile connectedness model. This approach allows for a nuanced investigation of connectedness ...and adds to understanding the monetary policy transmission mechanism within a highly integrated international financial system. Substantial interest rate changes (in either direction) matter for connectedness in financial markets. The results also indicate which currency drives developments depending on the direction of the change in interest rates. The full implementation and replication code — based on R, is available at: https://github.com/GabauerDavid/ConnectednessApproach.
•We study connectedness in IRS markets and include a magnitude dimension.•Large positive or negative interest rate changes increase connectedness.•Substantial variations are observed across major markets and over time.•The results have implications for the monetary transmission mechanism.
The popular Nelson–Siegel Nelson, C.R., Siegel, A.F., 1987. Parsimonious modeling of yield curves. Journal of Business 60, 473–489 yield curve is routinely fit to cross sections of intra-country bond ...yields, and Diebold–Li Diebold, F.X., Li, C., 2006. Forecasting the term structure of government bond yields. Journal of Econometrics 130, 337–364 have recently proposed a dynamized version. In this paper we extend Diebold–Li to a global context, modeling a potentially large
set of country yield curves in a framework that allows for both global and country-specific factors. In an empirical analysis of term structures of government bond yields for the Germany, Japan, the UK and the US, we find that global yield factors do indeed exist and are economically important, generally explaining significant fractions of country yield curve dynamics, with interesting differences across countries.
We identify the effects of monetary policy on credit risk-taking with an exhaustive credit
register of loan applications and contracts. We separate the changes in the composition of the
supply of ...credit from the concurrent changes in the volume of supply and quality and volume
of demand. We employ a two-stage model that analyzes the granting of loan applications in
the first stage and loan outcomes for the applications granted in the second stage, and that
controls for both observed and unobserved, time-varying, firm and bank heterogeneity through
time*firm and time*bank fixed effects. We find that a lower overnight interest rate induces
lowly capitalized banks to grant more loan applications to ex-ante risky firms and to commit
larger loan volumes with fewer collateral requirements to these firms, yet with a higher expost likelihood of default. A lower long-term interest rate and other relevant macroeconomic
variables have no such effects.
Understanding of complex relationships among economic variables has much significance for investors, researchers and policy makers alike. This study is conducted to examine dynamic linkages among ...gold price, stock prices, exchange rate and interest rate nexus using monthly data of Pakistan economy ranging from 2001-1 to 2014–12. Search of the best model motivates the use of Bayesian inference. Hence, the study is also used to compare performance of classical VAR model and Bayesian VAR model under four types of priors. It may be considered another significant contribution in terms of methodological framework. All the four variables are nonstationary at level but stationary at first difference. However, no long-run relationship among the variables is found by employing three cointegration tests, i.e. JJ test without considering structural break, GH test considering one unknown structural break and HJ test allowing two unknown structural breaks. Hence short-run relationship is analyzed in the study. Bayesian VAR model under independent normal inverse Wishart priors is selected as the best model which is then used to conduct impulse response analysis. Inverse bilateral relationships between stock prices and gold price as well as between rupee value and gold price are determined where as positive bilateral relationship between stock prices and rupee value is explored. It implies that stock prices and rupee value move downward during recessionary periods but gold becomes more pretty and vice versa also hold. Hence, gold is not only considered as safe haven but it is also considered as an alternative investment during adverse fluctuations in stock and foreign exchange markets of Pakistan. Changes in stock prices and rupee value are negatively responded by monetary policy makers in Pakistan but changes in gold prices are not considered by monetary authorities. Results also reveal that monetary policy actions significantly and adversely affect the three markets under consideration. Direct relationship between nominal interest rate and exchange rate in Pakistan conform to the International fisher effect theory.
•Better performance of Bayesian VAR model using independent Normal Inverse Wishart Priors as compare to classical VAR model.•Short-run dynamic inter-linkages of fluctuations in gold market, stock market and foreign exchange market of Pakistan.•Role of gold as safe heaven as well as alternative investment for investors during adverse fluctuations in stock and foreign exchange markets.•Unidirectional causality from interest rate to gold price.•Acceptance of international fisher effect theory due to direct inter-relationship between nominal interest rate and exchange rate in Pakistan.
The standard class of affine models produces poor forecasts of future Treasury yields. Better forecasts are generated by assuming that yields follow random walks. The failure of these models is ...driven by one of their key features: Compensation for risk is a multiple of the variance of the risk. Thus risk compensation cannot vary independently of interest rate volatility. I also describe a broader class of models. These "essentially affine" models retain the tractability of standard models, but allow compensation for interest rate risk to vary independently of interest rate volatility. This additional flexibility proves useful in forecasting future yields.
This research studies the non‐linear relationship between interest rates and exchange rates for China and the United States using the rolling‐window method. We also investigate uncovered interest ...rate parity (UIP) and the capital market theory for the whole time period and subperiods so as to reconsider various economic connections between China and the United States. The results suggest that the effect of the latter's interest rate adjustment on China/U.S. exchange rate volatility is stronger than that of China's interest rate adjustment. Moreover, changes in the China/U.S. exchange rate have a slightly stronger effect on the U.S. interest rate than on China's interest rate. Our findings reveal that the interest rate parity theory does not hold for the entire sample period but may hold in subperiods. The results provide a reference for the steady implementation of RMB internationalization.
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