Information in the Term Structure of Yield Curve Volatility
Duke University, Fuqua School of Business
Norges Bank Investment Management
October 28, 2014
Journal of Finance, Forthcoming
We decompose conditional volatilities of US Treasury yields into components due to short-rate expectations and term premia. To this end, we propose a novel no-arbitrage model which we estimate with extensive second-moment data. Short-rate expectations become more volatile than premia before recessions and during asset market distress. The correlation between shocks to premia and expectations is close to zero on average and varies with stance of monetary policy. While Treasuries are nearly unexposed to variance shocks, investors pay a large premium for hedging variance risk with derivatives. We illustrate the distinct dynamics of those yield volatility components during and after the financial crisis.
Number of Pages in PDF File: 53
Keywords: yield curve, stochastic volatility
JEL Classification: E43, C51
Date posted: August 20, 2009 ; Last revised: July 17, 2015
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