Deconstructing the Yield Curve
67 Pages Posted: 10 Apr 2019 Last revised: 16 May 2019
Date Written: April 1, 2019
We investigate the factor structure of the term structure of interest rates and argue that characterizing the minimal dimension of the data-generating process is more challenging than currently appreciated. To circumvent these difficulties, we introduce a novel nonparametric bootstrap that is robust to general forms of time and cross-sectional dependence and conditional heteroskedasticity of unknown form. We show that our bootstrap procedure is asymptotically valid and exhibits excellent finite-sample properties in simulations. We demonstrate the applicability of our results in two empirical exercises: First, we show that measures of equity market tail risk and the state of the macroeconomy predict bond returns beyond the level or slope of the yield curve; second, we provide a bootstrap-based bias correction and confidence intervals for the probability of recession based on the shape of the yield curve. Our results apply more generally to all assets with a finite maturity structure.
Keywords: term structure of interest rates, factor models, principal components, bond risk premiums, resampling-based inference
JEL Classification: C15, C58, G10, G12
Suggested Citation: Suggested Citation