Economics
Yield Curve Forecasting
Yield curve forecasting is a method used to predict future economic conditions based on the shape of the yield curve, which plots the interest rates of bonds with different maturities. By analyzing the slope and movement of the yield curve, economists and investors can gain insights into potential changes in inflation, economic growth, and monetary policy. This forecasting tool is valuable for making informed investment and policy decisions.
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8 Key excerpts on "Yield Curve Forecasting"
eBook - ePubAn Introduction to Banking
Liquidity Risk and Asset-Liability Management
- Moorad Choudhry(Author)
- 2011(Publication Date)
- Wiley(Publisher)
The yield curve describes the relationship between a particular yield and its term to maturity. So, plotting yields of a set of bonds along the maturity structure will give us our yield curve. The primary yield curve in any domestic capital market is the government bond yield curve – for example, in the US market it is the US Treasury yield curve. Outside government bond markets, yield curves are plotted for Eurobonds, money market instruments, off-balance-sheet instruments – in fact, virtually all debt market instruments. So, it is always important to remember to compare like for like when analysing yield curves across markets. Using the yield curve The yield curve tells us where the bond market is trading now. It also implies the level of trading for the future, or at least what the market thinks will be happening in the future. In other words, it is a good indicator of the future level of the market. It is also a much more reliable indicator than any other used by private investors, and we can prove this empirically. But, for the moment take my word for it! As an introduction to yield curve analysis, let us first consider its main uses. All participants in debt capital markets will be interested in the current shape and level of the yield curve, as well as what this information implies for the future. The main uses are summarized below. Setting the yield for all debt market instruments. The yield curve essentially fixes the price of money over the maturity structure. The yields of government bonds from the shortest maturity instrument to the longest set the benchmark for yields for all other debt instruments in the market, around which all debt instruments are priced. What does this mean? Essentially, it means that if a government 5-year bond is trading at a yield of 5.00%, all other 5-year bonds, whoever they are issued by, will be issued at a yield over 5.00%. The amount over 5.00% that the other bond trades is known as the spread
eBook - ePubThe Moorad Choudhry Anthology
Past, Present and Future Principles of Banking and Finance
- Moorad Choudhry(Author)
- 2018(Publication Date)
- Wiley(Publisher)
The yield curve essentially fixes the cost of money over the maturity term structure. The yields of government bonds from the shortest maturity instrument to the longest set the benchmark for yields for all other debt instruments in the market, around which all debt instruments are analysed. Issuers of debt (and their underwriting banks) therefore use the yield curve to price bonds and all other debt instruments. Generally, the zero‐coupon yield curve is used to price new issue securities, rather than the redemption yield curve.Acting as an Indicator of Future Yield Levels
As we discuss later in this chapter, the yield curve assumes certain shapes in response to market expectations of future interest rates. Bond market participants analyse the present shape of the yield curve in an effort to determine the implications regarding the future direction of market interest rates. This is perhaps one of the most important functions of the yield curve. The yield curve is scrutinised for its information content, not just by bond traders and fund managers, but also by corporate financiers as part of the project appraisal process. Central banks and government treasury departments also analyse the yield curve for its information content, with regard to expected inflation levels.Measuring and Comparing Returns Across the Maturity Spectrum
Portfolio managers use the yield curve to assess the relative value of investments across the maturity spectrum. The yield curve indicates the returns that are available at different maturity points and is therefore very important to fixed‐income fund managers, who can use it to assess which point of the curve offers the best return relative to other points.Indicating Relative Value Between Different Bonds of Similar Maturity
The yield curve can be analysed to indicate which bonds are cheap or dear to the curve. Placing bonds relative to the zero‐coupon yield curve helps to highlight which bonds should be bought or sold either outright or as part of a bond spread trade.
eBook - PDF- Moorad Choudhry, Graham "Harry" Cross, Jim Harrison(Authors)
- 2003(Publication Date)
- Butterworth-Heinemann(Publisher)
Generally the zero-coupon yield curve is used to price new issue securities, rather than the redemption yield curve. Acting as an indicator of future yield levels As we discuss later in this chapter, the yield curve assumes certain shapes in response to market expectations of the future interest rates. Bond market participants analyse the present shape of the yield curve in an effort to determine the implications regarding the future direction of market interest rates. This is perhaps one of the most important func-tions of the yield curve, and it is as much an art as a science. The yield curve is scrutinised for its information content not just by bond traders and fund managers but also by corporate financiers as part of project appraisal. Central banks and government treasury departments also analyse the yield curve for its information content, not just regarding forward interest rates but also with regard to expected inflation levels. 193 Measuring and comparing returns across the maturity spectrum Portfolio managers use the yield curve to assess the relative value of investments across the maturity spectrum. The yield curve indicates the returns that are available at different maturity points and is therefore very important to fixed-income fund managers, who can use it to assess which point of the curve offers the best return relative to other points. Indicating relative value between different bonds of similar maturity The yield curve can be analysed to indicate which bonds are cheap or dear to the curve. Placing bonds relative to the zero-coupon yield curve helps to highlight which bonds should be bought or sold either outright or as part of a bond spread trade. Pricing interest rate derivative securities The price of derivative securities revolves around the yield curve. At the short end, products such as Forward Rate Agreements are priced off the futures curve, but futures rates reflect the market's view on forward three-month cash deposit rates.
- Michael Brandl(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
A yield curve shows the yield, or interest rate, paid on bonds of different maturities at one point in time (Figure 4-3). Yield curve: Graph of the yields of bonds or debt at one point in time. An important thing to remember: “Term” set on the horizontal axis identifies the terms, or lengths to maturity, of the bonds we are examining at one point in time. That is, the horizontal axis is not , in this case, a measurement of time into the future as in what interest rates will be in the future. 4-4b Yield Curve Facts We want to use the yield curve graph to explain the following facts about interest rates: 1. A yield curve generally slopes upward. This means that, holding everything else constant, the yield on long-term bonds tends to be higher than the yield on short-term bonds. 2. The slope of a yield curve can and does change. That is, sometimes the yield curve is flat, or there is not much difference between short-term yields and long-term yields, whereas other times the yield curve is steep, meaning there is a big difference between short-term yields and long-term yields; and sometimes the yield curve slopes downward. This downward-sloping yield curve is sometimes called an “inverted” yield curve. 3. There often are parallel shifts in a yield curve. That is, over time, short-term and long-term interest rates tend to move together. Sometimes all interest rates increase, or the 4-4 3 mo 6 mo 1 yr 5 yr 10 yr 30 yr Term Yield Yield curve Figure 4-3 The Yield Curve Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.
- A. Berkelaar, J. Coche, K. Nyholm, A. Berkelaar, J. Coche, K. Nyholm(Authors)
- 2009(Publication Date)
- Palgrave Macmillan(Publisher)
for the forecast. Yet this does not diminish the importance of taking the cor- relation between the yield curves into account when proposing trading ideas. In fact, another good exercise is to use the forecast of the Euro curve given by Figure 3 to check the consistency of the two views with a third view on the Euro curve provided by the analyst, for instance. Bibliography Alexander, C. (2008a). Market Risk Analysis, Volume II: Practical Financial Econometrics. John Wiley & Sons. Alexander, C. (2008b). ‘Moving Average Models for Volatility and Correlation’. In Handbook of Finance, Volume 1. Fabozzi, F.J. (ed.), Wiley. Black, F. and Litterman, R. (1992). ‘Global Portfolio Optimization’. Financial Analysts Journal, 48(5): 28–43. Updating the Yield Curve to Analyst’s Views 43 Diebold, F. and Li, C. (2006). ‘Forecasting the Term Structure of Government Bond Yields’. Journal of Econometrics, 130(2), 337–364. Diebold, F., Li, C., and Yue, V. (2008). ‘Global Yield Curve Dynamics and Interactions: A Generalized Nelson-Siegel Approach’. Journal of Econometrics, 146, 351–363. Hyvarinen, A., Karhunen, J., and Oja, E. (2001). Independent Component Analysis. Wiley-Interscience. Jolliffe, I. (2002). Principal Component Analysis. Springer, 2nd edition. Loretan, M. (1997). ‘Generating Market Risk Scenarios using Principal Components Analysis: Methodological and Practical Considerations’. In The Measurement of Aggregate Market Risk. Bank for International Settlements, CGFS Publications 7. Meucci, A. (2005). Risk and Asset Allocation. Springer. Nelson, C. and Siegel, A. (1987). ‘Parsimonious Modeling of Yield Curves’. Journal of Business, 60, 473–489. Rachev, S., Hsu, J., Bagasheva, B., and Fabozzi, F. (2008). Bayesian Methods in Finance. John Wiley & Sons. 44 3 A Spread-Risk Model for Strategic Fixed-Income Investors Fernando Monar Lora and Ken Nyholm 3.1 Introduction Surprisingly little attention has been paid in the academic literature to the forecasting of credit spreads 1 .
eBook - ePub- Suresh Sundaresan(Author)
- 2009(Publication Date)
- Academic Press(Publisher)
stripping coupon-paying bonds and reconstitutions of strips into coupon bonds.8.1 Yield-Curve Analysis
Yield curve is a term used to describe the plot of yield to maturity against time to maturity or against a risk measure, such as the modified duration of debt securities in a certain market segment (such as Treasury or corporate bonds). It is therefore natural to speak of “Treasury yield curve” or “corporate AAA yield curve.” By incorporating the expectations of diverse participants in the marketplace, the shape of the yield curve succinctly captures and summarizes the cost of credit for various maturities of different issuers. The shape of the default-free yield curve is, therefore, of considerable interest to practitioners in the financial markets. To get some basic understanding of this concept, we plot the yield to maturity along the Y axis and time to maturity along the X axis using all 160 Treasury debt securities that were outstanding for settlement on July 11, 2008. Figure 8.1 shows the resulting plot of the yield curve as of that date.Figure 8.1 Treasury Yield Curve quoted as of July 11, 2008Source: Wall Street Journal.Several features of the yield curve are worth noting. First, note the sparseness of yield data for maturities in the range 2029 through 2035. This is due to the fact that 30-year T-bond auctions were cancelled during the period March 2001 to January 2006 and were only resumed in February 2006. Second, the yield curve is relatively flat in the far end (longer maturity sector) and somewhat steep in the front maturities. Finally, we note that there are some debt securities whose yields plot well outside the general area around which the yields have clustered. Even within the same maturity range, yields tend to differ. Some of the outstanding debt issues were callable, and not surprisingly these were trading at a higher yield. We explore this activity later in the chapter.
- Moorad Choudhry(Author)
- 2001(Publication Date)
- Butterworth-Heinemann(Publisher)
convergence with interest rates in euroland. These are both medium-term expectations however, and in the author’s view not logical at the short-end of the yield curve. In fact the term structure moved to a positive-sloped shape up to the 6–7 year area, before inverting out to the long-end of the curve, in June 1999. This is a more logical shape for the curve to assume, but it was short-lived and returned to being inverted after the 2-year term.There is therefore significant information content in the yield curve, and economists and bond analysts will consider the shape of the curve as part of their policy making and investment advice. The shape of parts of the curve, whether the short-end or long-end, as well that of the entire curve, can serve as useful predictors of future market conditions. As part of an analysis it is also worthwhile considering the yield curves across several different markets and currencies. For instance the interest-rate swap curve, and its position relative to that of the government bond yield curve, is also regularly analysed for its information content. In developed country economies the swap market is invariably as liquid as the government bond market, if not more liquid, and so it is common to see the swap curve analysed when making predictions about say, the future level of short-term interest rates. We will consider the swap curve again in Part VI .Government policy will influence the shape and level of the yield curve, including policy on public sector borrowing, debt management and open-market operations. The markets perception of the size of public sector debt will influence bond yields; for instance an increase in the level of debt can lead to an increase in bond yields across the maturity range. Open-market operations, which refers to the daily operation by the Bank of England to control the level of the money supply (to which end the Bank purchases short-term bills and also engages in repo dealing), can have a number of effects. In the short-term it can tilt the yield curve both upwards and downwards; longer term, changes in the level of the base rate will affect yield levels. An anticipated rise in base rates can lead to a drop in prices for short-term bonds, whose yields will be expected to rise; this can lead to a temporary inverted curve. Finally debt management policy will influence the yield curve. (In the United Kingdom this is now the responsibility of the Debt Management Office.) Much government debt is rolled over as it matures, but the maturity of the replacement debt can have a significant influence on the yield curve in the form of humps in the market segment in which the debt is placed, if the debt is priced by the market at a relatively low price and hence high yield.
eBook - PDF- G. Gregoriou, R. Pascalau, G. Gregoriou, R. Pascalau(Authors)
- 2010(Publication Date)
- Palgrave Macmillan(Publisher)
Latent Factors of the Yield Curve 131 the curvature effect is not incompatible with the fact that also the TS slope varies across the business cycle. A flat yield curve is usually interpreted as a sign of imminent reces- sion since relative high short- to long-term rates are assumed to reflect a severe monetary policy stance (Bernanke and Blinder 1992). On the contrary, an upward-sloping yield curve reflects expectations about an accommodative monetary policy and, thus, is indicative of a thriving economy. Suppose the economy is growing fast so that strong aggregate demand is likely to generate inflationary pressures. Suppose further the monetary authority raises interest rates to preserve price stability. Two effects may follow. On the one hand, the yield spread shrinks, since short yields are likely to increase by a larger amount than long-term yields; on the other hand, aggregate demand weakens, following the reduc- tion of private investments. The adjustment process of the long end of the yield curve following the shock affecting the short end implies an intermediate step occurring at medium-term maturities, where the cor- responding yields rise by more than long-term ones. The propagation along the entire spectrum of TS maturities generates a temporary spike in the medium end of the yield curve. Therefore, both the dynamics of the yield curve and the evolution of the macroeconomic conditions occur at the same time. Expectations may either accelerate or anticipate the process. The contrary happens before a recession. Expectations of accommodative monetary policy exert a negative pressure on TS medium maturities thus causing curvature to drop (Figure 7.1). In this chapter we do not intend to establish any causality relation between curvature and real economy, we simply suggest that curvature reflects the cycli- cal behavior of the economy.
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