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The Central Tendency: A Second Factor in Bond Yields

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  • Pierluigi Balduzzi
  • Sanjiv Ranjan Das
  • Silverio Foresi

Abstract

We assume that the instantaneous riskless rate reverts towards a central tendency which in turn, is changing stochastically over time. As a result, current short-term rates are not" sufficient to predict future short-term rates movements, as would be the case if the central" tendency was constant. However, since longer-maturity bond prices incorporate information" about the central tendency, longer-maturity bond yields can be used to predict future short-term" rate movements. We develop a two-factor model of the term-structure which implies that a" linear combination of any two rates can be used as a proxy for the central tendency. Based on" this central-tendency proxy, we estimate a model of the one-month rate which performs better" than models which assume the central tendency to be constant.

Suggested Citation

  • Pierluigi Balduzzi & Sanjiv Ranjan Das & Silverio Foresi, 1997. "The Central Tendency: A Second Factor in Bond Yields," NBER Working Papers 6325, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:6325
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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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