A factor model of term structure slopes in eurocurrency markets

This paper departs from previous research in dealing with dimensionality reduction in the space of international term structure slopes. Recent empirical work has documented the existence of information in the slope of the term structure which is relevant to forecast future changes in economic activity, and it is additional to information in past economic activity, inflation, or in any leading indicator index [see Estrella and Hardouvelis (1991), Stock and Watson (1988), Hardouvelis (1994) and Plosser and Rouwenhorst (1994), among others]. This implies that a good forecasting model of term structure slopes could be helpful to anticipate changes in economic activity with an even longer anticipation.Term structure of interest rates, Term structure slope, Principal components, Eurocurrencies.

The Inverted Yield Curve and the Components of GDP

When 3-month Treasury rates are greater than 10 -year Treasury rates an inverted yield curve occurs. When this state is reached some argue that a recession is on the horizon, typically 6 months to a year down the road. Here, I reframe the question of whether inverted yield curves predict recessions in the US and ask what an inverted yield curve predicts. Using a Probit model I find that when 10-year US Treasury bonds yield less than 3-month US Treasury bills, a US recession, while probable, is not certain. Moreover, I find that indeed the strength of this indicator has weakened over the last 20 years. However, my findings do not suggest that an inverted yield curve provides no information about the future. In fact, I find that an inverted yield curve strongly predicts movements in the consumer durables and fixed private investment series of US GDP

Dynamic correlations and forecasting of term structure slopes in eurocurrency market

Using monthly data on Euro-rates for 1979-1998, we examine the extent to which crosscountry information on term structure slopes can be used to improve upon univariate slope forecasts. This is interesting from the point of view of forecasting economic activity, since term structure slopes are known to anticipate fluctuations in the real economy. Additionally, the Expectations Hypothesis states that the term structure slope summarizes the available information which is relevant for forecasting future short-term interest rates, so that improved slope forecasts might also lead to better forecasts of future interest rates. We find ample evidence of significant explanatory power in term structure slopes across countries. Besides, we document that this information content leads to improved forecasts of the term structure slope in some countries, using a foreign slope as indicator.Term structure of interest rates, Term structure slope, Expectations hypothesis, Eurocurrencies.

Predicting European Union recessions in the euro era: The yield curve as a forecasting tool of economic activity

Several studies have established the predictive power of the yield curve, ie: the difference between long and short term bond rates, in terms of real economic activity, for the U.S. and various European countries. In this paper we use data from the European Union (EU15), ranging from 1994:Q1 to 2008:Q3. The seasonally adjusted real GDP is used to extract the long run trend and the cyclical component of the European output, while the European Central Bank’s euro area government benchmark bonds of various maturities are used for the calculation of the yield spreads. We also augment the models tested with non monetary policy variables: the unemployment and a composite European stock price index constructed from the indices of the three major European stock markets of London, Frankfurt and Paris. The methodology employed in the effort to forecast recessions, is a probit model of the inverse cumulative distribution function of the standard distribution, using several formal forecasting evaluation tests. The results show that the yield curve augmented with the composite stock index has significant forecasting power in terms of the EU15 real output.forecasting, yield spread, recession, probit, term structure, monetary policy, real growth

The Yield Spread and Inflation as Economic Forecasting Variables in the UK

The thesis investigates the possibility of predicting future economic activity using the yield spread of a UK Treasury bond and bill, and a inflation variable. To investigate this matter, this paper uses the theoretical framework of the relationship between the term structure and economic growth. It is found that the chosen yield spread on its on holds some significance in forecasting future quarters of economic movement, whereas the inflation variable holds less significanc

The effect of interest rate options hedging on term-structure dynamics

Market participants and policymakers closely monitor movements in the yield curve for information about future economic fundamentals. In several recent episodes, however, disruptions to market liquidity have affected the short-term dynamics of the curve independently of fundamentals. This article provides evidence that the short-run dynamics in the intermediate maturities of the yield curve changed around 1990, with the appearance of positive feedback in weekly interest rate changes. The feedback is consistent with the effects of options dealers’ hedging activity and it is found only in the 1990s, after the interest rate options market grew to significant size. The authors also show that the market liquidity/positive-feedback effects are concentrated in the weeks after the largest interest rate changes. Their results suggest that the times when market participants and policymakers are most interested in extracting from the yield curve a signal about economic fundamentals are precisely the times when changes in the curve may be distorted by liquidity effects.Interest rates ; Options (Finance) ; Hedging (Finance) ; Rate of return ; Liquidity (Economics)

Previsão de Recessão Através da Curva de Juros: Uma análise para o caso brasileiro

TCC (graduação) - Universidade Federal de Santa Catarina. Centro Sócio-Econômico. Economia.O presente trabalho busca reproduzir o modelo de previsão de crises através da curva da taxa de juros, como apresentado por Estrella e Hardouvelis (1991). A curva de juros brasileira é construída, são apresentadas as curvas de spread para a economia brasileira e americana e um histórico dos períodos de recessão de ambas economias são estimados utilizando a metodologia proposta por Estrella e Hardouvellis (1991). O objetivo foi testar a validade do modelo, com estimação através de um Probit, para períodos mais atuais no caso da economia americana e para o caso da economia brasileira. Foi encontrado que o modelo continuou com poder de previsão de crises para a economia americana, mas o mesmo não foi verdade para a economia brasileira, que apresenta uma série de dados disponíveis muito menor que da economia americana, sendo que foram encontrados indícios de uma possível existência de dependência da economia brasileira em relação às taxas de juros de longo prazo americanas.The present work seeks to reproduce the crisis forecasting model through the yield curve, as presented by Estrella and Hardouvelis (1991). The objective was to test the validity of the model, with estimation through a Probit, for more current periods for the American economy and for the Brazilian economy. It was found that it continues to have crisis-prediction power for the American economy, but the same was not true for the Brazilian economy, with evidence suggesting that the Brazilian economy is dependent on long-term US rates

A wavelet approach to the dynamic relation between the Portuguese Yield Curve and Macroeconomic Growth

The goal of this work project is to discuss and analyze the relation between the components of the Portuguese yield curve and the economy’s level of activity for the period between 1996 and 2018. Based on traditional parametric methods, the macro-finance mode developed includes a dynamic latent factor model containing the conventional latent factors level, slope and curvature. The behavior of these variables is simultaneously analyzed in the time and frequency domains, using for that purpose wavelet transforms and wavelet tools. By applying the wavelet transformation to all time series data under analysis it possible to study the dynamic relationship among them in terms of direction, intensity, synchronization and periodicit

The Information in the High Yield Bond Spread for the Business Cycle: Evidence and Some Implications

The market for high yield (below investment-grade) corporate bonds developed in the middle 1980s. We show that, since this time, the high yield spread has had significant explanatory power for the business cycle. We interpret this finding as possibly symptomatic of financial factors at work in the business cycle, along the lines suggested by the financial accelerator. We also show that over this period the high yield spread outperforms other leading financial indicators, including the term spread, the paper-bill spread and the Federal Funds rate. We conjecture that changes in the conduct of monetary policy over time may account for the reduced informativeness of these alternative indicators, all of which are tied closely to monetary policy.