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Common factors, principal components analysis, and the term structure of interest rates

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  • Juneja, Januj

Abstract

This paper studies common factor structure of bond returns from the US, UK and Germany. We estimate factors using both principal components analysis and common principal components analysis (CPCA), and construct factor mimicking portfolios to provide interpretations for some of these factors. A regression analysis of these portfolios shows that the common factors relate mostly to the level and steepness of the term structure in the US, with the first common factor explains approximately 90% of the variation. We use simulations to show that the power of the CPC test statistic to detect similarities in the factor structure which comprises our sample is limited.

Suggested Citation

  • Juneja, Januj, 2012. "Common factors, principal components analysis, and the term structure of interest rates," International Review of Financial Analysis, Elsevier, vol. 24(C), pages 48-56.
    • Handle: RePEc:eee:finana:v:24:y:2012:i:c:p:48-56
    DOI: 10.1016/j.irfa.2012.07.004
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    1. Driessen, J.J.A.G. & Melenberg, B. & Nijman, T.E., 2003. "Common factors in international bond returns," Other publications TiSEM 06a83942-b625-4d3c-808c-a, Tilburg University, School of Economics and Management.
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    Cited by:

    1. Bruno Scalzo Dees, 2019. "Analysing Global Fixed Income Markets with Tensors," Papers 1908.02101, arXiv.org, revised Dec 2019.
    2. Choudhry, Taufiq, 2016. "Time-varying risk premium yield spread effect in term structure and global financial crisis: Evidence from Europe," International Review of Financial Analysis, Elsevier, vol. 48(C), pages 303-311.
    3. Wellmann, Dennis & Trück, Stefan, 2018. "Factors of the term structure of sovereign yield spreads," Journal of International Money and Finance, Elsevier, vol. 81(C), pages 56-75.
    4. Juneja, Januj, 2017. "How Germany benefits the most from its Eurozone membership," Research in International Business and Finance, Elsevier, vol. 42(C), pages 1074-1088.
    5. Fang, Ming & Taylor, Stephen & Uddin, Ajim, 2022. "The network structure of overnight index swap rates," Finance Research Letters, Elsevier, vol. 46(PB).
    6. Linhai Wu & Liwei Zhang & Yufeng Li, 2023. "Basis for fulfilling responsibilities, behavior, and professionalism of government agencies and effectiveness in public–public collaboration for food safety risk management," Palgrave Communications, Palgrave Macmillan, vol. 10(1), pages 1-16, December.
    7. Baker, H. Kent & Kumar, Satish & Goyal, Kirti & Sharma, Anuj, 2021. "International review of financial analysis: A retrospective evaluation between 1992 and 2020," International Review of Financial Analysis, Elsevier, vol. 78(C).
    8. Joel R. Barber, 2021. "Empirical analysis of term structure shifts," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 45(2), pages 360-371, April.

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    More about this item

    Keywords

    Bond returns; Principal components analysis; Common factors; Term structure of interest rates;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications

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