The Yield Curve Through Time and Across Maturities

31 Pages Posted: 12 Mar 2007

See all articles by Richard Startz

Richard Startz

UCSB

Kwok Ping Tsang

Virginia Polytechnic Institute & State University

Date Written: March 8, 2007

Abstract

We develop an unobserved component model in which the short-term interest rate is composed of a stochastic trend and a stationary cycle. Using the Nelson-Siegel model of the yield curve as inspiration, we estimate an extremely parsimonious state-space model of interest rates across time and maturity. Our stochastic process generates a three-factor model for the term structure. At the estimated parameters, trend and slope factors matter while the third factor is empirically unimportant. Our baseline model fits the yield curve well. Model generated estimates of uncertainty are positively correlated with estimated term premia. An extension of the model with regime switching identifies a high-variance regime and a low-variance regime, where the high-variance regime occurs rarely after the mid-1980s. The term premium is higher, and more so for yields of short maturities, in the high-variance regime than that in the low-variance regime. The estimation results support our model as a simple and yet reliable framework for modeling the term structure.

Keywords: term structure of interest rates, Nelson-Siegel yield curve, trend-cycle decomposition

JEL Classification: C22, E32, E43

Suggested Citation

Startz, Richard and Tsang, Kwok Ping, The Yield Curve Through Time and Across Maturities (March 8, 2007). Available at SSRN: https://ssrn.com/abstract=969828 or http://dx.doi.org/10.2139/ssrn.969828

Richard Startz (Contact Author)

UCSB ( email )

Department of Economics
University of California
Santa Barbara, CA 93106-9210
United States
805-893-2895 (Phone)

Kwok Ping Tsang

Virginia Polytechnic Institute & State University ( email )

250 Drillfield Drive
Blacksburg, VA 24061
United States

HOME PAGE: http://https://sites.google.com/site/byrontkp/

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