Factors of the Term Structure of Sovereign Yield Spreads

38 Pages Posted: 9 Apr 2016 Last revised: 21 Nov 2017

See all articles by Dennis Wellmann

Dennis Wellmann

Macquarie University

Stefan Trück

Macquarie University Sydney - Department of Applied Finance and Actuarial Studies; Financial Research Network (FIRN); Centre for International Finance and Regulation (CIFR); Macquarie University, Macquarie Business School

Date Written: November 20, 2017

Abstract

We investigate the term structure of sovereign yield spreads for five advanced economies against the US and provide novel insights on the key drivers of the term structure. We show that the spread term structure dynamics are driven by three latent factors, which can be labeled as spread level, slope and curvature similar to common interpretations found in the yield curve literature. We further show that these estimated spread factors have predictive power for exchange rate movements and excess returns, above the predictability of an uncovered interest rate parity approach. As the yield curve contains information about expected future economic conditions we conjecture that these yield spread factors reflect expected macroeconomic differentials which in turn drive exchange rates. Using the information content of yield spread curves may thus be a promising approach to improve the forecasting accuracy of exchange rate models.

Keywords: Sovereign Yield Spreads, Term Structure Modeling, Principal Component Analysis, Macroeconomic Fundamentals, Exchange Rate Forecasts

JEL Classification: E43, F31, F37, G15, G17

Suggested Citation

Wellmann, Dennis and Trueck, Stefan, Factors of the Term Structure of Sovereign Yield Spreads (November 20, 2017). FIRN Research Paper No. 2760709. Available at SSRN: https://ssrn.com/abstract=2760709 or http://dx.doi.org/10.2139/ssrn.2760709

Dennis Wellmann

Macquarie University ( email )

North Ryde
Sydney, New South Wales 2109
Australia

Stefan Trueck (Contact Author)

Macquarie University Sydney - Department of Applied Finance and Actuarial Studies ( email )

North Ryde
Sydney, New South Wales 2109
Australia
61298508483 (Phone)
61298508483 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Centre for International Finance and Regulation (CIFR) ( email )

Level 7, UNSW CBD Campus
1 O'Connell Street
Sydney, NSW 2000
Australia

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

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