A global model of international yield curves: no-arbitrage term structure approach
AbstractThis paper extends a popular no-arbitrage affine term structure model to model jointly bond markets and exchange rates across the United Kingdom, United States and euro area. Using a monthly data set of forward rates from 1992, we first demonstrate that two global factors account for a significant proportion in the variation of bond yields across countries. We also show that, in order to explain country-specific movements in yield curves, local factors are required. Although we implement a very general factor structure, we find that our global factors are related to global inflation and global economic activity, while local factors are closely linked to monetary policy rates. In this respect our results are similar to previous work. But an important advantage of our joint international model is that we are able to decompose interest rates into risk-free rates and risk premia. Additionally, we are able to study the implications for exchange rates. We show that while differences in risk-free rates matter, to a large extent changes in the exchange rate are determined by time-varying exchange rate risk premia.
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Bibliographic InfoPaper provided by Bank of England in its series Bank of England working papers with number 419.
Length: 37 pages
Date of creation: 12 Apr 2011
Date of revision:
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More information through EDIRC
Term structure models; exchange rates.;
Find related papers by JEL classification:
- C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- F31 - International Economics - - International Finance - - - Foreign Exchange
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-23 (All new papers)
- NEP-CBA-2011-04-23 (Central Banking)
- NEP-EEC-2011-04-23 (European Economics)
- NEP-MON-2011-04-23 (Monetary Economics)
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