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Extrapolating Long-Maturity Bond Yields for Financial Risk Measurement

Author

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  • Jens H. E. Christensen

    (Federal Reserve Bank of San Francisco, San Francisco, California 94105)

  • Jose A. Lopez

    (Federal Reserve Bank of San Francisco, San Francisco, California 94105)

  • Paul L. Mussche

    (Federal Reserve Bank of San Francisco, San Francisco, California 94105)

Abstract

Insurance companies and pension funds have liabilities far into the future and typically well beyond the longest maturity bonds trading in fixed-income markets. Such long-lived liabilities still need to be discounted, and yield curve extrapolations based on the information in observed yields can be used. We use dynamic Nelson-Siegel (DNS) yield curve models to extrapolate risk-free yield curves for Switzerland and several countries. We find slight biases in extrapolated long bond yields of just a few basis points. In addition, the DNS model allows the generation of useful financial risk metrics, such as ranges of possible yield outcomes over projection horizons commonly used for stress-testing purposes. Therefore, we recommend using DNS models as a simple tool for generating extrapolated yields for long-term interest rate risk management.

Suggested Citation

  • Jens H. E. Christensen & Jose A. Lopez & Paul L. Mussche, 2022. "Extrapolating Long-Maturity Bond Yields for Financial Risk Measurement," Management Science, INFORMS, vol. 68(11), pages 8286-8300, November.
    • Handle: RePEc:inm:ormnsc:v:68:y:2022:i:11:p:8286-8300
    DOI: 10.1287/mnsc.2021.4215
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    More about this item

    Keywords

    term structure modeling; capital regulation of insurance companies;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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