A No-Arbitrage Structural Vector Autoregressive Model of the UK Yield Curve
33 Pages Posted: 22 Dec 2008
Date Written: December 22, 2008
This paper combines a structural vector autoregression (SVAR) with a no-arbitrage approach to build a multifactor affine term structure model (ATSM). The resulting no-arbitrage structural vector autoregressive (NA-SVAR) model implies that expected excess returns are driven by the structural macroeconomic shocks. This is in contrast to a standard ATSM, in which agents are concerned with non-structural risks. As a simple application of a NA-SVAR model, we study the effects of supply, demand and monetary policy shocks on the UK yield curve. We show that all shocks affect the slope of the yield curve, with demand and supply shocks accounting for a large part of the time variation in bond yields. The short end of the yield curve is driven mainly by the expectations component, while the term premium matters for the dynamics of the long end of the yield curve.
Keywords: Structural vector autoregression, interest rate risk, essentially affine term structure model
JEL Classification: C32, E43, E44
Suggested Citation: Suggested Citation