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An Empirical Analysis of the Curvature Factor of the Term Structure of Interest Rates

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Matteo Modena

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Abstract

This work extends the strand of literature that examines the relation between the term structure of interest rates and macroeconomic variables. The yield curve is summarized by few latent factors (level, slope, and curvature) which are obtained through Kalman filtering. In this paper, we address the challenging issue of attributing an economic interpretation to the third unobservable component of the term structure, i.e. curvature. In particular, we find significant evidence suggesting that curvature reflects the cyclical fluctuations of the economy. Interestingly, this result holds in spite of whether the curvature factor is extracted from the nominal or the real term structure. A negative shock to curvature seems either to anticipate or to accompany a slowdown in economic activity. The curvature effect thus appears to complement the transition from an upward sloping yield curve to a flat one. Finally, a joint macro-econometric model for curvature and real activity is developed and estimated.

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Paper provided by Department of Economics, University of Glasgow in its series Working Papers with number 2008_35.

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Date of creation: Sep 2008
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Handle: RePEc:gla:glaewp:2008_35

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Related research
Keywords: Term Structure; Kalman Filtering; Latent Factors; Curvature; Business Cycle;

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Find related papers by JEL classification:
C01 - Mathematical and Quantitative Methods - - General - - - Econometrics
C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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