Time-Varying Volatility and the Dynamic Behavior of the Term Structure
29 Pages Posted: 27 Apr 2000 Last revised: 25 Jul 2022
Date Written: April 1991
In this paper, we consider a framework with which the cross sectional and time series behavior of the yield curve can be studied simultaneously. We examine the relationship between the yield curve and the time-varying conditional volatility of the Treasury bill market. We demonstrate that differently shaped yield curves can result given different combinations of volatility and expectations about future spot rates. Moreover, adjusting the forward rate for the volatility related liquidity premium can improve its performance as a predictor of future spot rates at least for the period from August 1964 to August 1979.
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