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Analyzing Interest Rate Risk: Stochastic Volatility in the Term Structure of Government Bond Yields

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Author Info

  • Nikolaus Hautsch

    () (Humboldt-Universität zu Berlin)

  • Yangguoyi Ou

    () (Humboldt-Universität zu Berlin)

Abstract

We propose a Nelson-Siegel type interest rate term structure model where the underlying yield factors follow autoregressive processes with stochastic volatility. The factor volatilities parsimoniously capture risk inherent to the term structure and are associated with the time-varying uncertainty of the yield curve’s level, slope and curvature. Estimating the model based on U.S. government bond yields applying Markov chain Monte Carlo techniques we find that the factor volatilities follow highly persistent processes. We show that slope and curvature risk have explanatory power for bond excess returns and illustrate that the yield and volatility factors are closely related to industrial capacity utilization, inflation, monetary policy and employment growth.

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Bibliographic Info

Paper provided by Center for Financial Studies in its series CFS Working Paper Series with number 2009/03.

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Length: 45 pages
Date of creation: 03 Jan 2009
Date of revision:
Handle: RePEc:cfs:cfswop:wp200903

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Keywords: Term Structure Modelling; Yield Curve Risk; Stochastic Volatility; Factor Models; Macroeconomic Fundamentals;

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References

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  1. Francis X. Diebold & Monika Piazzesi & Glenn D. Rudebusch, 2005. "Modeling bond yields in finance and macroeconomics," Working Paper Series 2005-04, Federal Reserve Bank of San Francisco.
  2. Francis X. Diebold & Canlin Li, 2004. "Forecasting the Term Structure of Government Bond Yields," CFS Working Paper Series 2004/09, Center for Financial Studies.
  3. John H. Cochrane & Monika Piazzesi, 2002. "Bond Risk Premia," NBER Working Papers 9178, National Bureau of Economic Research, Inc.
  4. 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.
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Cited by:
  1. Cem Çakmakli, 2012. "Bayesian Semiparametric Dynamic Nelson-Siegel Model," Working Paper Series 59_12, The Rimini Centre for Economic Analysis, revised Sep 2012.

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