Research Review | 30 April 2021 | Interest Rates & Yield Curves

Forecasting Bond Risk Premia using Stationary Yield Factors
Tobias Hoogteijling (Robeco Asset Management), et al.
April 12, 2021
The standard way to summarize the yield curve is to use the first three principal components of the yield curve, resulting in level, slope and curvature factors. Yields, however, are non-stationary. We analyze the first three principal components of yield changes, which correspond to changes in level, slope and curvature. The new factors based on changes in yields have strong predictive power for bond risk premia, in contrast to the factors based on yield levels. We also provide insights into the impact this has on the added value of macro data for bond risk premia predictions and the recent conclusion that machine learning provides better forecasts than linear regression.

Beyond the Yield Curve: Understanding the Effect of FOMC Announcements on the Stock Market
Christoph Boehm and Niklas Kroner (University of Texas at Austin)
March 25, 2021
A large literature uses high-frequency changes in interest rates around FOMC announcements to study monetary policy. These yield changes have puzzlingly low explanatory power for the stock market – even in a narrow 30-minute window. We propose a new approach to test whether the unexplained variation represents monetary policy news or just noise. In particular, we allow for a latent “Fed non-yield curve shock”, which we estimate via a heteroskedasticity-based procedure. Using a test for weak identification, we show that our shock is well identified, that is, the unexplained variation is not just noise. We then go on to show that the shock, signed to increase stock prices, leads to sizable declines in the equity and variance premium, an increase in the 10-year term premium, an increase in short-run inflation expectations, as well as a dollar depreciation against multiple non-safe-haven currencies. Hence, the evidence supports the interpretation that the shock affects risk-appetite and leads to a reverse “flight-to-safety” effect. Lastly, using a method from the computational linguistics literature, we show that our shock can be linked to specific topics discussed in FOMC statements, suggesting that it reflects written communication by the Federal Reserve.

Does the Yield Curve Predict Output?
Joseph G. Haubrich (Cleveland Fed)
November 6, 2020
Does the yield curve have the ability to predict output and recessions? At some times and in certain places, of course! But many details are matters of dispute: When and where does the yield curve predict successfully, which aspects of the curve matter most, and which economic forces account for the predictive ability? Over the years, an increasingly sophisticated set of tools, both statistical and theoretical, have addressed these issues. For the US, an inverted yield curve, particularly when the spread between the yield on 10-year and 3-month Treasuries becomes negative, has been a robust indicator of recessions in the post-World War Two period. The spread also predicts future real GDP growth for the US, although the forecast ability varies by time period, in ways that appear to depend on monetary policy. The evidence is less clear in other countries, but the yield curve shows some predictive ability for the UK and Germany, among others.

It’s Worse than ‘Reverse’: The Full Case Against Ultra Low and Negative Interest Rates
Michael D. Bordo (Rutgers) and Joseph G. Haubrich (Cleveland Fed)
August 6, 2020
Does the yield curve’s ability to predict future output and recessions differ when interest rates are low, as in the current global environment? In this paper we build on recent econometric work by Shi, Phillips, and Hurn that detects changes in the causal impact of the yield curve and relate that to the level of interest rates. We explore the issue using historical data going back to the 19th century for the United States and more recent data for the United Kingdom, Germany, and Japan. This paper is similar in spirit to Ramey and Zubairy (2018), who look at the government spending multiplier in times of low interest rates.

International Yield Spillovers
Don H. Kim and Marcelo Ochoa (Federal Reserve)
January 2021
This paper investigates spillovers from foreign economies to the U.S. through changes in longterm Treasury yields. We document a decline in the contribution of U.S. domestic news to the variance of long-term Treasury yields and an increased importance of overnight yield changes—a rough proxy for the contribution of foreign shocks to U.S. yields—over the past decades. Using a model that identifies U.S., Euro area, and U.K. shocks that move global yields, we estimate that foreign (non-U.S.) shocks account for at least 20 percent of the daily variation in long-term U.S. yields in recent years. We argue that spillovers occur in large part through bond term premia by showing that a low level of foreign yields relative to U.S. yields predicts a decline in distant forward U.S. yields and higher returns on a strategy that is long on a long-term Treasury security and short on a long-term foreign bond.


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One thought on “Research Review | 30 April 2021 | Interest Rates & Yield Curves

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