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Report
The short end of the forward convergence curve and asymmetric cat's tail convergence
How is the term structure able to predict future interest rates several months in the future and why is it so steep at the short end? Recent empirical work shows that rates of mean reversion are too slow to help predict short rates or to account for the curve's steepness. We propose that short term interest rates are predictable because Federal Reserve actions are predictable. In particular, our estimates suggest that the market anticipates the Fed's monetary stance twelve months in advance. Moreover, forward rates contain more information when the Fed is expected to tighten than when it is ...
Report
What was the market's view of U.K. monetary policy? Estimating inflation risk and expected inflation with indexed bonds
A measure of the credibility of monetary policy is the inflation risk premium in nominal yields. This will be time varying and can be estimated by combining the information in the nominal term structure with that in the real term structure. We estimate these risk premia using a generalized CIR affine-yield model, with one factor driving the real term structure of monthly observations on two-year, five-year and ten-year UK index-linked debt and two factors driving the term structure of the corresponding nominal yields. Our estimates show that the inflation risk premium contributes on average ...
Journal Article
Risk management by structured derivative product companies
In the early 1990s, some U.S. securities firms and foreign banks began creating subsidiary vehicles--known as structured derivative product companies (DPCs)--whose special risk management approaches enabled them to obtain triple-A credit ratings with the least amount of capital. At first, market observers expected credit-sensitive customers to turn increasingly to these DPCs. However, the authors find that structured DPCs--despite their superior ratings--have failed to live up to their initial promise and have yet to gain a competitive edge as intermediaries in the derivatives markets.
Report
Two factors along the yield curve
We estimate two-factor equilibrium models on different parts of the yield curve. In this exploration of the term structure of interest rates, we use two-factor affine yield models as our diagnostic tool. The exercise provides insights on how to reconcile the time-series dynamics of interest rates with the cross-sectional shapes of the term structure and on how movements in the yield curve are related to macroeconomic fundamentals. The evidence favors models in which one factor reverts over time to a time-varying mean. One such model seems adequate to explain three-month to two-year bond ...
Working Paper
Asia's financial crisis: lessons and policy responses
This paper argues that fundamental weaknesses in Asian financial systems that had been masked by rapid growth were at the root of East Asia's 1997 currency and financial crisis. These weaknesses were caused by the lack of incentives for effective risk management created by implicit or explicit government guarantees against failure. The weakness of the financial sector was accentuated by large capital inflows, which were partly encouraged by pegged exchange rates. ; Policy responses need to be designed to restore growth in an environment of macroeconomic stability in the short run, and to ...
Report
What moves the bond market?
We take a close look at a year in the U.S. Treasury market and try to explain the sharpest price changes and most active trading episodes. The virtue of our analysis lies in its use of high-frequency data on market movements and accurate release times for a comprehensive set of economic announcements. For the period August 1993 to August 1994, we attribute the 25 largest price moves and 25 greatest trading surges to just-released announcements. The bond market's response to announcements in general is consistent with the way we would expect it to react to new information.
Report
A three-factor econometric model of the U.S. term structure
We estimate and test a model of the U.S. term structure that fits both the time series of interest rates and the cross-sectional shapes of the yield and volatility curves. In the model, three unobserved factors drive a stochastic discount process that prices assets so as to rule out arbitrage opportunities. The resulting bond yields are conveniently affine in the factors. We use monthly zero-coupon yield data from January 1986 to March 1996 and estimate the model by applying a Kalman filter that takes into account the model's no-arbitrage restrictions and using only three maturities at a ...