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A naive approach to forecast inverted yield curve risk with theta model

Author

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  • Ouyang, Tianhao
  • Qiu, Guobin
  • Wang, Haolun
  • Chen, Huamai

Abstract

When in yield curve or term structure, the long or mid-term bond interest rate became lower than short-term interest, the phenomenon is called inverted yield curve (IYC). In the last 20 years, the most severe catastrophe after an IYC is the 08 Financial Crisis. IYC indicates that in the long run, the economic risk will be much higher than the short run. Thus, a prediction on IYC can buy more time to confirm an upcoming instability if not outright financial and economic turbulence. This paper presents a naïve approach to forecast IYC by measuring interests-prediction errors. The method indicates a clean “Hard X shape” comes before IYC which could bring investors or regulators an early warning with a few months’ lead for preparing financial or other aspects of counter-measures.

Suggested Citation

  • Ouyang, Tianhao & Qiu, Guobin & Wang, Haolun & Chen, Huamai, 2025. "A naive approach to forecast inverted yield curve risk with theta model," Finance Research Letters, Elsevier, vol. 86(PC).
    • Handle: RePEc:eee:finlet:v:86:y:2025:i:pc:s1544612325017696
    DOI: 10.1016/j.frl.2025.108515
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