Riding the Yield Curve: A Spanning Analysis
32 Pages Posted: 22 Aug 2010 Last revised: 8 Jan 2012
Date Written: July 2, 2010
The average return on long-term bonds exceeds the return on short-term bills by a large amount over short investment horizons. A riding-the-yield-curve investment strategy takes advantage of the higher returns on longer term bonds. This strategy involves the purchase of bonds with maturities longer than the investment horizon and the sale of these bonds, before they mature, at the end of the investment horizon. Most of the literature that evaluates this strategy compares only ex post average returns or Sharpe ratios. In this paper, we use spanning tests to provide formal statistical evidence on the benefits of investing in long bonds when the investment horizon is short. The results for both the US and Canada indicate that an investor with a short horizon is better off investing in short-term debt instruments than long-term bonds.
Keywords: Yield curve, Spanning, Mean Variance, Portfolio Allocation
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