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The Yield Curve, Inflation Expectations, and Economic Uncertainty

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  • Kang, In-bong

Abstract

Not only individual interest rates but spreads between long-term and short-term interest rates experienced large fluctuations during the period covering several months before and after the recent foreign exchange crisis. In June 1997 the market yields on 3- year corporate bonds and 3-month commercial papers were 11.65% and 12.05%, respectively, and the spread between them (i.e. the 3-year corporate bond yield minus the 3-month commercial paper yield; henceforth CCP) was just - 40 basis points. Six months later the 3-year and 3-month rates jumped up to 24.31% and 29.26%, respectively, with the spread enlarging to - 495 basis points. During the same period the yields on the 3- year and 1-year industrial finance debentures (IFD) that were issued by the governmentowned Korea Development Bank also fluctuated large: from 12.08% and 12.25%, respectively, in June 1997 to 22.41% and 20.02% in January 1998 and then down to 6.90% and 6.92% in June 1999. So did the long-short spread between them (henceforth FF): from -17 basis points to +239 basis points to - 2 basis points. The present paper makes an attempt to understand what factors are responsible for causing such large fluctuations in long-short interest rate spreads. It develops an empirical model of the term structure of interest rates, based on the preferred habitat theory, where long-short spreads are related to inflation expectations (or short-term interest rates) and economic uncertainty. The model is then estimated and tested to see if the relationship is supported by data. A vector autoregression (VAR) model is also used to examine how long-short spreads respond to innovations to the two factors and which of the two factors is more important in explaining the forecast error variance of long-short spreads. The sample period under study is January 1991 - September 2000 and the frequency of the data is monthly.

Suggested Citation

  • Kang, In-bong, 2001. "The Yield Curve, Inflation Expectations, and Economic Uncertainty," KDI Policy Studies 2001-01, Korea Development Institute (KDI).
    • Handle: RePEc:zbw:kdipol:200101
    DOI: 10.22740/kdi.ps.e.2001.01
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    Cited by:

    1. Hyun Don Lee & Sang-Bum Park, 2016. "An Empirical Study on the Factors Affecting Savings Bank Loan Interest Rates," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 8(12), pages 175-182, December.

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