The Central Tendency: A Second Factor in Bond Yields

Posted: 9 Mar 2011 Last revised: 14 Mar 2011

See all articles by Pierluigi Balduzzi

Pierluigi Balduzzi

Boston College - Carroll School of Management

Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business

Silverio Foresi

Goldman Sachs Group, Inc. - Quantitative Strategy Group

Multiple version iconThere are 6 versions of this paper

Date Written: 1998

Abstract

We assume that the instantaneous riskless rate reverts toward a central tendency which, in turn, is changing stochastically over time. As a result, current short-term rates are not sufficient to predict future short- term rate movements, as it would be the case if the central tendency were constant. However, since longer maturity bond prices incorporate information about the central tendency, longer maturity bond yields can be used to predict future short-term rate movements. We develop a two-factor model of the term structure which implies that a linear combination of any two rates can be used as a proxy for the central tendency. Based on this central-tendency proxy, we estimate a model of the one-month rate that performs better than models which assume the central tendency to be constant.

Suggested Citation

Balduzzi, Pierluigi and Das, Sanjiv Ranjan and Foresi, Silverio, The Central Tendency: A Second Factor in Bond Yields (1998). Review of Economics and Statistics, Vol. 80, No. 1, 1998, Available at SSRN: https://ssrn.com/abstract=1781139

Pierluigi Balduzzi

Boston College - Carroll School of Management ( email )

Department of Finance
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Chestnut Hill, MA 02467
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617-552-0431 (Fax)

HOME PAGE: http://www.bc.edu/bc_org/avp/csom/faculty/

Sanjiv Ranjan Das (Contact Author)

Santa Clara University - Leavey School of Business ( email )

Department of Finance
316M Lucas Hall
Santa Clara, CA 95053
United States

HOME PAGE: http://srdas.github.io/

Silverio Foresi

Goldman Sachs Group, Inc. - Quantitative Strategy Group ( email )

32 Old Slip, 24th Floor
New York, NY 10005
United States
(212) 357-3508 (Phone)

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