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Movements in the term structure of interest rates

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Author Info
Robert R. Bliss
Abstract

Bond prices tend to move together. Stocks tend to go their own way. This distinction requires completely different approaches to managing risks for these securities. For equities the emphasis is on reducing idiosyncratic risk through portfolio diversification. For interest rate-sensitive securities it is on precisely balancing a portfolio to achieve the desired exposure to systematic risk factors. ; Hedging to reduce or eliminate the common factors influencing an interest rate-sensitive portfolio's value requires a model of interest rate behavior. This article reviews and extends previous studies showing that term structure movements can be decomposed into three components-changes in the general level of interest rates, changes in the slope of the term structure, and changes in the curvature of the term structure. It presents empirical analysis showing that since 1970 the structure of these factors has not changed appreciably even though interest rate volatility has. The author provides a numerical example demonstrating that hedging based on the factor decomposition is superior to hedging based on the traditional method of Macaulay duration.

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Publisher Info
Article provided by Federal Reserve Bank of Atlanta in its journal Economic Review.

Volume (Year): (1997)
Issue (Month): Q 4 ()
Pages: 16-33
Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF
Handle: RePEc:fip:fedaer:y:1997:i:q4:p:16-33:n:v.82no.4

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Keywords: Bonds ; Interest rates ; Stocks;

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November. [Downloadable!] (restricted)
  2. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, vol. 53(2), pages 385-407, March. [Downloadable!] (restricted)
  3. Christopher A. Sims & Tao Zha, 1995. "Error bands for impulse responses," Working Paper 95-6, Federal Reserve Bank of Atlanta. [Downloadable!]
    Other versions:
  4. Dhrymes, Phoebus J & Friend, Irwin & Gultekin, N Bulent, 1984. " A Critical Reexamination of the Empirical Evidence on the Arbitrage Pricing Theory," Journal of Finance, American Finance Association, vol. 39(2), pages 323-46, June. [Downloadable!] (restricted)
  5. Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December. [Downloadable!] (restricted)
  6. Duffee, Gregory R, 1996. " Idiosyncratic Variation of Treasury Bill Yields," Journal of Finance, American Finance Association, vol. 51(2), pages 527-51, June. [Downloadable!] (restricted)
  7. Robert R. Bliss & David C. Smith, 1997. "The stability of interest rate processes," Working Paper 97-13, Federal Reserve Bank of Atlanta. [Downloadable!]
  8. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-92, September. [Downloadable!] (restricted)
  9. Knez, Peter J & Litterman, Robert & Scheinkman, Jose Alexandre, 1994. " Explorations into Factors Explaining Money Market Returns," Journal of Finance, American Finance Association, vol. 49(5), pages 1861-82, December. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Konstantijn Maes, 2004. "Modeling the Term Structure of Interest Rates: Where Do We Stand?," Research series 200402, National Bank of Belgium. [Downloadable!]
    Other versions:
  2. Borus Jungbacker & Siem Jan Koopman & Michel van der Wel, . "Dynamic Factor Models with Smooth Loadings for Analyzing the Term Structure of Interest Rates," Tinbergen Institute Discussion Papers 09-041/4, Tinbergen Institute. [Downloadable!]
    Other versions:
  3. Juan Marcelo, Ochoa, 2006. "An Interpretation of An Affine Term Structure Model for Chile," MPRA Paper 1072, University Library of Munich, Germany. [Downloadable!]
    Other versions:
  4. Jorge Barros Luís & Nuno Cassola, 2001. "A two-factor model of the German term structure of interest rates," Working Paper Series 46, European Central Bank. [Downloadable!]
  5. C. Emre Alper & Aras Akdemir & Kazim Kazimov, 2004. "Estimating Yield Curves in Turkey: Factor Analysis Approach," Working Papers 2004/04, Bogazici University, Department of Economics. [Downloadable!]
  6. Francis X. Diebold, 2004. "The Nobel Memorial Prize for Robert F. Engle," CFS Working Paper Series 2004/11, Center for Financial Studies. [Downloadable!]
    Other versions:
  7. Francis X. Diebold & Canlin Li, 2004. "Forecasting the Term Structure of Government Bond Yields," CFS Working Paper Series 2004/09, Center for Financial Studies. [Downloadable!]
    Other versions:
  8. Dennis Philip & Chihwa Kao & Giovanni Urga, 2007. "Testing for Instability in Factor Structure of Yield Curves," Center for Policy Research Working Papers 96, Center for Policy Research, Maxwell School, Syracuse University. [Downloadable!]
  9. A. Onatski & V. Karguine, 2005. "Curve Forecasting by Functional Autoregression," Computing in Economics and Finance 2005 59, Society for Computational Economics. [Downloadable!]
    Other versions:
  10. Oliver Blaskowitz & Helmut Herwartz & Gonzalo de Cadenas Santiago, 2005. "Modeling the FIBOR/EURIBOR Swap Term Structure: An Empirical Approach," SFB 649 Discussion Papers SFB649DP2005-024, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany. [Downloadable!]
    Other versions:
  11. Nuno Cassola & Jorge Barros Luís, 2003. "A two-factor model of the German term structure of interest rates," Applied Financial Economics, Taylor and Francis Journals, vol. 13(11), pages 783-806, November. [Downloadable!] (restricted)
  12. Francis X. Diebold & Canlin Li & Vivian Z. Yue, 2007. "Global Yield Curve Dynamics and Interactions: A Dynamic Nelson-Siegel Approach," NBER Working Papers 13588, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  13. Marcelo Ochoa, 2006. "Interpreting an Affine Term Structure Model for Chile," Working Papers Central Bank of Chile 380, Central Bank of Chile. [Downloadable!]
  14. Raúl Susmel & Madhu Kalimipalli, 2001. "Regime-Switching Stochastic Volatility and Short-Term Interest Rates," CEMA Working Papers: Serie Documentos de Trabajo. 197, Universidad del CEMA. [Downloadable!]
  15. Hans Dewachter & Konstantijn Maes & Kristien Smedts, 2003. "Monetary unification and the price of risk: An unconditional analysis," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 139(2), pages 276-305, June. [Downloadable!] (restricted)
    Other versions:
  16. Oliver Blaskowitz & Helmut Herwatz, 2008. "Adaptive Forecasting of the EURIBOR Swap Term Structure," SFB 649 Discussion Papers SFB649DP2008-017, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany. [Downloadable!]
  17. Martin Cihak, 2004. "Stress Testing: A Review of key Concepts," Research and Policy Notes 2004/02, Czech National Bank, Research Department. [Downloadable!]
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