TY - UNPB

T1 - Specification Analysis of International Treasury Yield Curve Factors

AU - Tiozzo Pezzoli, Luca

AU - Fulvio, Pegoraro

AU - Siegel, Andrew F

PY - 2014

Y1 - 2014

N2 - 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.

AB - 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.

KW - EM algorithm

KW - Kalman Filter and Kalman Smoother

KW - common and local factors

KW - international treasury yield curves

KW - state-space models

KW - EM algorithm

KW - Kalman Filter and Kalman Smoother

KW - common and local factors

KW - international treasury yield curves

KW - state-space models

UR - http://hdl.handle.net/10807/153918

U2 - 10.2139/ssrn.2456656

DO - 10.2139/ssrn.2456656

M3 - Working paper

BT - Specification Analysis of International Treasury Yield Curve Factors

ER -