Riding the Yield Curve: Risk Taking Behavior in a Low Interest Rate Environment

Ralph Chami, Thomas Cosimano, Celine Rochon and Julieta Yung

No 2020/053, IMF Working Papers from International Monetary Fund

Abstract: Investors seek to hedge against interest rate risk by taking long or short positions on bonds of different maturities. We study changes in risk taking behavior in a low interest rate environment by estimating a market stochastic discount factor that is non-linear and therefore consistent with the empirical properties of cashflow valuations identified in the literature. We provide evidence that non-linearities arise from hedging strategies of investors exposed to interest rate risk. Capital losses are amplified when interest rates increase and risk averse investors have taken positions on instruments with longer maturity, expecting instead interest rates to revert back to their historical average.

Keywords: WP; Interest rate risk; non-linear stochastic discount factor; investment portfolio; term structure model; risk aversion distribution; low interest rate environment; averse investor; interest-rate risk factors; hedging strategy; investors aversion; expected SDF; interest rate movement; Yield curve; Bonds; Securities; Market risk; Securities markets; Global (search for similar items in EconPapers)
Pages: 26
Date: 2020-03-13
New Economics Papers: this item is included in nep-rmg and nep-upt
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