Analyzing Interest Rate Risk: Stochastic Volatility in the Term Structure of Government Bond Yields
AbstractWe 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 InfoPaper provided by Center for Financial Studies in its series CFS Working Paper Series with number 2009/03.
Length: 45 pages
Date of creation: 03 Jan 2009
Date of revision:
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More information through EDIRC
Term Structure Modelling; Yield Curve Risk; Stochastic Volatility; Factor Models; Macroeconomic Fundamentals;
Other versions of this item:
- Hautsch, Nikolaus & Ou, Yangguoyi, 2012. "Analyzing interest rate risk: Stochastic volatility in the term structure of government bond yields," Journal of Banking & Finance, Elsevier, vol. 36(11), pages 2988-3007.
- C5 - Mathematical and Quantitative Methods - - Econometric Modeling
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
- G1 - Financial Economics - - General Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-06-03 (All new papers)
- NEP-CBA-2009-06-03 (Central Banking)
- NEP-MAC-2009-06-03 (Macroeconomics)
- NEP-MON-2009-06-03 (Monetary Economics)
- NEP-ORE-2009-06-03 (Operations Research)
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.:
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Working Paper Series
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- Francis X. Diebold & Monika Piazzesi & Glenn D. Rudebusch, 2005. "Modeling Bond Yields in Finance and Macroeconomics," CFS Working Paper Series 2005/03, Center for Financial Studies.
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CFS Working Paper Series
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- Francis X. Diebold & Canlin Li, 2002. "Forecasting the Term Structure of Government Bond Yields," Center for Financial Institutions Working Papers 02-34, Wharton School Center for Financial Institutions, University of Pennsylvania.
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- 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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