The Term Structure of Interest Rates and Macro-Portfolio Returns

47 Pages Posted: 16 Feb 2009 Last revised: 16 Sep 2011

Paul A. Bekker

University of Groningen

Kees E. Bouwman

Cardano Risk Management

Date Written: August 31, 2011

Abstract

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.

Keywords: Term structure of interest rates, Yield curve, Linearity-generating processes, Market price of risk, Business cycle

JEL Classification: E43, G12

Suggested Citation

Bekker, Paul A. and Bouwman, Kees E., The Term Structure of Interest Rates and Macro-Portfolio Returns (August 31, 2011). Midwest Finance Association 2012 Annual Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1342556 or http://dx.doi.org/10.2139/ssrn.1342556

Paul A. Bekker

University of Groningen ( email )

P.O. Box 800
9700 AH Groningen
Netherlands

Kees E. Bouwman (Contact Author)

Cardano Risk Management ( email )

Rotterdam 3011 AA
Netherlands

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