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Testing for Instability in Factor Structure of Yield Curves

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Author Info
Dennis Philip () (Cass Business School, City University, 106 Bunhill Road, London EC1Y 8TZ, UK)
Chihwa Kao () (Center for Policy Research, Maxwell School, Syracuse University, Syracuse, NY 13244-1020)
Giovanni Urga () (Cass Business School, City University, 106 Bunhill Row, London EC1Y 8TZ, U.K.)

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Abstract

A widely relied upon but a formally untested consideration is the issue of stability in actors underlying the term structure of interest rates. In testing for stability, practitioners as well as academics have employed ad yhoc techniques such as splitting the sample into a few sub-periods and determining whether the factor loadings have appeared to be similar over all sub-periods. Various authors have found mixed evidence on stability in the actors. In this paper we develop a formal testing procedure to evaluate the factor structure stability of the US zero coupon yield term structure. We find the factor structure of level to be unstable over the sample period considered. The slope and curvature factor structures are however found to be stable. Common structural changes affecting all interest rate maturities have fostered instability in the level factor. We corroborate the literature that variances (volatility) explained by the level, slope, and curvature factors are unstable over time. We find that the volatility of slope factor is sensitive to shocks affecting the short rates and the volatility of curvature factor is sensitive to shocks affecting the medium and long rates. Finally, we find evidence of the presence of common economic shocks affecting the level and slope factors, unlike slope and curvature factors that responded differently to economic shocks and were unaffected by any common instabilities.

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Publisher Info
Paper provided by Center for Policy Research, Maxwell School, Syracuse University in its series Center for Policy Research Working Papers with number 96.

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Length: 53 pages
Date of creation: Jul 2007
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Handle: RePEc:max:cprwps:96

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Related research
Keywords: Stability factor structure principal component analysis term structure of interest rates.

Find related papers by JEL classification:
C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Hypothesis Testing
C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Estimation
C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Semiparametric and Nonparametric Methods
C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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    Other versions:
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    Other versions:
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  7. Gray, Stephen F., 1996. "Modeling the conditional distribution of interest rates as a regime-switching process," Journal of Financial Economics, Elsevier, vol. 42(1), pages 27-62, September. [Downloadable!] (restricted)
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  13. Garcia, Rene & Perron, Pierre, 1996. "An Analysis of the Real Interest Rate under Regime Shifts," The Review of Economics and Statistics, MIT Press, vol. 78(1), pages 111-25, February. [Downloadable!] (restricted)
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  14. Andrews, Donald W K, 1993. "Tests for Parameter Instability and Structural Change with Unknown Change Point," Econometrica, Econometric Society, vol. 61(4), pages 821-56, July. [Downloadable!] (restricted)
    Other versions:
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