Exploiting Predictability in the Time-Varying Shape of the Term Structure of Interest Rates

This paper presents evidence of predictability in the time-varying shape of the U.S. term structure of interest rates using a robust recursive modelling approach based on a Bayesian mixture of multi-factor models.

Author(s):

Frank J. Fabozzi, Frederick Frank

Adjunct Professor of Finance at Yale School of Management in New Haven, CT

Lionel Martellini

Professor of Finance and Scientific Director of the EDHEC Risk and Asset Management Research Centre

Philippe Priaulet

Derivatives Strategist at HSBC-CCF in Paris and Associate Professor in the Department of Mathematics at the University of Evry Val d'Essonne, France.

We find that variables such as default spread, equity volatility, short-term and forward rates, among others, can be used to predict changes in the slope of the yield curve, and also, albeit to a lesser extent, changes in the curvature of the yield curve. By using systematic trading strategies based on butterfly swaps, we also find that this evidence of predictability in the shape of the yield curve is economically significant in addition to being statistically significant.

Type: Working paper
Date: le 06/08/2007
Research Cluster : Finance

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