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

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

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Nikolaus Hautsch () (Humboldt-Universität zu Berlin)
Yangguoyi Ou () (Humboldt-Universität zu Berlin)

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Nikolaus Hautsch

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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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
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Handle: RePEc:cfs:cfswop:wp200903

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Find related papers by JEL classification:
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)

References listed on IDEAS
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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. [Downloadable!]
Other versions:
- 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. [Downloadable!]
- Francis X. Diebold & Monika Piazzesi & Glenn D. Rudebusch, 2005. "Modeling Bond Yields in Finance and Macroeconomics," PIER Working Paper Archive 05-008, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania. [Downloadable!]
- Francis X. Diebold & Monika Piazzesi & Glenn Rudebusch, 2005. "Modeling Bond Yields in Finance and Macroeconomics," NBER Working Papers 11089, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
- Francis X. Diebold & Monika Piazzesi & Glenn D. Rudebusch, 2005. "Modeling Bond Yields in Finance and Macroeconomics," American Economic Review, American Economic Association, vol. 95(2), pages 415-420, May. [Downloadable!]
Diebold, Francis X. & Li, Canlin, 2006. "Forecasting the term structure of government bond yields," Journal of Econometrics, Elsevier, vol. 130(2), pages 337-364, February. [Downloadable!] (restricted)
Other versions:
- Francis X. Diebold & Canlin Li, 2003. "Forecasting the Term Structure of Government Bond Yields," NBER Working Papers 10048, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
- 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!]
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John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, vol. 95(1), pages 138-160, March. [Downloadable!]
Other versions:
- John H. Cochrane & Monika Piazzesi, 2002. "Bond Risk Premia," NBER Working Papers 9178, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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)

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