Specification Analysis of International Treasury Yield Curve Factors

57 Pages Posted: 20 Jun 2014

See all articles by Fulvio Pegoraro

Fulvio Pegoraro

Banque de France - Economics and Finance Research Center; CREST - Laboratoire de Finance et Assurance

Andrew F. Siegel

University of Washington - Department of Finance and Business Economics; National Bureau of Economic Research (NBER)

Luca Pezzoli

Banque de France

Date Written: June 2014

Abstract

We show how to compute patterns of variation over time, both among and within countries, that determine the international term structure of interest rates, using maximum likelihood within a linear Gaussian state-space framework. The simultaneous estimation of common factors (shared by all countries) and local factors (specific to one country) requires development of a normalization procedure beyond that of ordinary factor analysis. By jointly estimating common and local factors we avoid sequential estimation effects that may explain the lack of agreement in the multi-country term structure literature regarding not only the total number of latent factors required to explain the joint dynamics of yield curves, but also the number of common and of local factors. Using data on international yield curves of U.S., Germany, U.K. and Japan from January 1986 to December 2009, we generally find (analyzing yields in level and in difference) that a model with two common factors and three correlated local factors is preferred to a model (of similar complexity) that includes one common factor only or a model with only correlated local factors. In addition, each common factor closely mimics (or is similar to) a local factor extracted from a pure local factor model. We also reach the conclusion that dependence across international yield curves are driven, first, by the instantaneous correlation between local factors of different countries and, then, by the (full) autoregressive matrix of latent factors and by the matrix of common loadings.

Keywords: international treasury yield curves, common and local factors, state-space models, EM algorithm, Kalman Filter and Kalman Smoother

JEL Classification: G12, E43, C52

Suggested Citation

Pegoraro, Fulvio and Siegel, Andrew F. and Pezzoli, Luca, Specification Analysis of International Treasury Yield Curve Factors (June 2014). Banque de France Working Paper No. 490. Available at SSRN: https://ssrn.com/abstract=2456656 or http://dx.doi.org/10.2139/ssrn.2456656

Fulvio Pegoraro (Contact Author)

Banque de France - Economics and Finance Research Center ( email )

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HOME PAGE: http://www.crest.fr/pageperso/pegoraro/pegoraro.htm

Andrew F. Siegel

University of Washington - Department of Finance and Business Economics ( email )

Box 353200
Seattle, WA 98195
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Luca Pezzoli

Banque de France ( email )

Paris
France

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