The Term Structure of Interest Rates and Macro-Portfolio Returns
Paul A. Bekker
University of Groningen
Kees E. Bouwman
Cardano Risk Management
August 31, 2011
Midwest Finance Association 2012 Annual Meetings Paper
The paper presents an arbitrage-free yield model based on macro-portfolio dynamics. Apart from a level factor, detrended portfolio values serve as factors for the yield model. Using trend-balanced portfolios and parameters in terms of the instantaneous mean-variance frontier, risk premia and yield curve dynamics are modeled in a natural, integrated, parsimonious way. Positivity constraints on parameters and factors are formulated that guarantee the model is well posed. In an empirical analysis a four-factor model is applied to daily US Treasury yields. We estimate by quasi-maximum likelihood using the unscented Kalman filter. The model fits well, while the estimates of both parameters and factors satisfy the positivity constraints. The analysis reveals a strong link between business cycle variation in yields and risk premia.
Number of Pages in PDF File: 47
Keywords: Term structure of interest rates, Yield curve, Linearity-generating processes, Market price of risk, Business cycle
JEL Classification: E43, G12
Date posted: February 16, 2009 ; Last revised: September 16, 2011
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