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A Term Structure Decomposition of the Australian Yield Curve

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  • Richard Finlay

    (Reserve Bank of Australia)

  • Mark Chambers

    (Reserve Bank of Australia)

Abstract

We use data on coupon-bearing Australian Government bonds and overnight indexed swap (OIS) rates to estimate risk-free zero-coupon yield and forward curves for Australia from 1992 to 2007. These curves, and analysts’ forecasts of future interest rates, are then used to fit an affine term structure model to Australian interest rates, with the aim of decomposing forward rates into expected future overnight cash rates plus term premia. The expected future short rates derived from the model are on average unbiased, fluctuating around the average of actual observed short rates. Since the adoption of inflation targeting and the entrenchment of low and stable inflation expectations, term premia appear to have declined in levels and displayed smaller fluctuations in response to economic shocks. This suggests that the market has become less uncertain about the path of future interest rates. Towards the end of the sample period, term premia have been negative, suggesting that investors may have been willing to pay a premium for Commonwealth Government securities. Due to the complexity of the model and the difficulty of calibrating it to data, the results should not be interpreted too precisely. Nevertheless, the model does provide a potentially useful decomposition of recent changes in the expected path of interest rates and term premia.

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Paper provided by Reserve Bank of Australia in its series RBA Research Discussion Papers with number rdp2008-09.

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Date of creation: Dec 2008
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Handle: RePEc:rba:rbardp:rdp2008-09

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Keywords: expected future short rate; term premia; term structure decomposition; affine term structure model; zero-coupon yield;

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  1. de Jong, Frank, 1999. "Time-series and Cross-section Information in Affine Term Structure Models," CEPR Discussion Papers 2065, C.E.P.R. Discussion Papers.
  2. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
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