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Journal Article
Emerging Bond Markets and COVID-19: Evidence from Mexico
The pandemic caused by the coronavirus is depressing economic activity and severely straining government budgets globally. Without international support, the ability of emerging economies to weather this crisis will depend crucially on access to and the cost of borrowing in domestic government bond markets. Analyzing bond flows and risk premiums for Mexican government bonds during the pandemic gives some insights into a major emerging economy’s experience. Mexican risk premiums have increased more than 1 percentage point above predicted levels, pointing to tighter funding conditions for the ...
Journal Article
The corporate bond credit spread puzzle
It is common to view interest on a corporate bond as reflecting the risk-free, longer-term interest rate, such as that on a 10-year Treasury bond, plus a spread related to the credit risk of the corporation issuing the bond. However, empirical analysis of the determinants of corporate bond rates has turned out to be more demanding than it appears on the surface. This has led researchers to talk about a credit spread puzzle. In this Economic Letter we will first detail the evidence for the existence of such a credit spread puzzle. In a second step we will take a closer look at some of the ...
Working Paper
Extrapolating Long-Maturity Bond Yields for Financial Risk Measurement
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 for extrapolating risk-free yield curves for Switzerland, Canada, France, and the U.S. We find slight biases in extrapolated long bond yields of a few basis points. In addition, the DNS model allows the generation of useful financial risk ...
Journal Article
Assessing supervisory scenarios for interest rate risk
A new proposal by the Basel Committee on Banking Supervision for setting the amount of capital banks must hold against potential losses from interest rate risk uses only a few, very stylized scenarios. Analysis shows the proposed scenarios are extremely unlikely to occur. While they may be appropriate for setting bank capital guidelines, they are much less relevant for everyday risk management. Instead, using a modeling framework with a plausible range of interest rate scenarios would be more relevant to help banks manage their interest rate risk.
Working Paper
Market-Based Estimates of the Natural Real Rate: Evidence from Latin American Bond Markets
We provide market-based estimates of the natural real rate, that is, the steady-state short-term real interest rate, for Brazil, Chile, and Mexico. Our approach uses a dynamic term structure finance model estimated directly on the prices of individual inflation indexed bonds with adjustments for bond-specific liquidity and real term premia. First, we find that inflation-indexed bond liquidity premia in all three countries are sizable with significant variation. Second, we find large differences in their estimated equilibrium real rates: Brazil’s is large and volatile, Mexico’s is stable ...
Journal Article
Measuring Interest Rate Risk in the Very Long Term
Insurance companies write policies to cover potential risks far into the future. Because the life of these contracts can extend well beyond the 30-year maturities for the longest U.S. Treasuries, it?s difficult to measure the interest rate risk involved. A new study describes how the long-term interest rates required to evaluate such long-lived liabilities can be extrapolated from shorter-maturity bond yields using a standard yield curve model. These extrapolations are a useful tool since they have very small errors relative to the yield curve variation typically considered for risk ...
Working Paper
Bond Flows and Liquidity: Do Foreigners Matter?
In their search for yield in the current low interest rate environment, many investors have turned to sovereign debt in emerging economies, which has raised concerns about risks to financial stability from these capital flows. To assess this risk, we study the effects of changes in the foreign-held share of Mexican sovereign bonds on their liquidity premiums. We find that recent increases in foreign holdings of these securities have played a significant role in driving up their liquidity premiums. Provided the higher compensation for bearing liquidity risk is commensurate with the chance of a ...
Journal Article
TIPS and the risk of deflation
The low level of inflation and the sluggish pace of economic recovery have raised concerns about sustained deflation?an inflation rate below zero with a general fall in prices. However, the relative prices of inflation-indexed and non-indexed Treasury bonds, which historically have proven to be good measures of inflation expectations, suggest that financial market participants consider the probability of deflation to be low.
Journal Article
What’s Up with Inflation Expectations in Japan?
Both actual inflation and inflation expectations increased recently in Japan after decades of being undesirably low. An estimate based on nominal and real Japanese bond yields adjusted for liquidity and other risk premiums confirms that investors’ long-term inflation expectations have also increased. However, projections indicate that further increases are less likely and that long-term expected inflation in Japan is likely to remain anchored below the Bank of Japan’s 2% inflation target.
Journal Article
The Risk of Returning to the Zero Lower Bound
Following the global financial crisis, U.S. monetary policy was constrained by the zero lower bound for short-term interest rates for many years. It has since lifted off and rates have gradually climbed. However, in light of the continuing economic expansion, it is relevant to ask how likely it is for the lower bound on interest rates to again become a constraint on monetary policy. Analysis using several different approaches suggests that there currently appears to be a low risk of the economy returning to the zero lower bound for at least the next several years.