Determinants of the Yield Curve - a Model for the Relationship Between Risk and Yield
AbstractThis paper develops a model explaining the level and structure of bond yields and the yield curve based upon three principles. 1) Across different maturities along the yield curve, bond yields change with the proportional change in the risk or potential volatility of the bonds. 2) The incremental yield required as a bond's volatility increases by an infinitesimal amount is determined by the riskless interest rate. 3) The relationship between the yield of a bond and the riskless interest rate is governed by expectations of future riskless interest rates over the term of the bond. The model explains the entire spread of the yield curve based upon expectations of future short-term riskless interest rates and upon the potential volatility of default-free bonds. Expected future riskless rates are derived from market bond yields by the model. These expectations are unbiased predictors of actual future riskless interest rates and are somewhat more accurate than a commercial consensus forecast. Spreads between expected future riskless rates for three month and ten year maturities correlate more highly with future changes in real GDP than do the spreads between the three month and ten year yields themselves. The model produces weights so that paired barbell maturities more closely match a bullet maturity's yield than if the barbell maturities were weighted by duration, a widely used measure of potential volatility. Differences between the bullet and weighted barbell yields correlate significantly with future changes in yields. The model thus facilitates evaluation of current pricing and future expectations in the bond market.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoArticle provided by Capco Institute in its journal Journal of Financial Transformation.
Volume (Year): 26 (2009)
Issue (Month): ()
Contact details of provider:
Postal: 120 Broadway, 29th Floor New York, NY 10271
Phone: +1 212 284 8600
Web page: http://www.capco.com/
Interest rates; yield curve; bond yield; riskless interest rate; expectations; financial markets; interest rate expectations;
Find related papers by JEL classification:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Peter Springett).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.