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A factor risk model with reference returns for the US dollar and Japanese yen bond markets

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  • Bernadell, Carlos
  • Coche, Joachim
  • Nyholm, Ken
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    Abstract

    This paper develops a new methodology for simulating fixed-income return distributions. It is shown that a traditional factor risk model, when augmented with reference returns, is capable of generating visually consistent return distributions for a broad range of fixed income instruments such as government and nongovernment instruments in the US dollar and Japanese yen bond markets. The reference returns result from a regime-switching Nelson-Siegel yield curve model following Bernadell, Coche and Nyholm (2005). Empirical results are encouraging: simulated distributions exhibit most characteristics observed in the fixed income markets such as non-normal right-skewed distributions for short maturity instrument while instruments with longer maturity are closer to being normally distributed. JEL Classification: C15, C32, C53, G11, G15

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    Bibliographic Info

    Paper provided by European Central Bank in its series Working Paper Series with number 0641.

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    Date of creation: Jun 2006
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    Handle: RePEc:ecb:ecbwps:20060641

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    Keywords: factor risk model; Regime switching; scenario analysis;

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    1. Nelson, Charles R & Siegel, Andrew F, 1987. "Parsimonious Modeling of Yield Curves," The Journal of Business, University of Chicago Press, vol. 60(4), pages 473-89, October.
    2. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942.
    3. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
    4. Tao Wu & Glenn Rudebusch, 2003. "Macroeconomics and the Yield Curve," Computing in Economics and Finance 2003 206, Society for Computational Economics.
    5. Bernadell, Carlos & Coche, Joachim & Nyholm, Ken, 2005. "Yield curve prediction for the strategic investor," Working Paper Series 0472, European Central Bank.
    6. Peter Kennedy, 2003. "A Guide to Econometrics, 5th Edition," MIT Press Books, The MIT Press, edition 5, volume 1, number 026261183x, December.
    7. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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