US and Chinese yield curve responses to RMB exchange rate policy shocks

Zhiwu Hong, Linlin Niu and Gengming Zeng

China Finance Review International, 2019, vol. 9, issue 3, 360-385

Abstract: Purpose - Using a discrete-time version of the arbitrage-free Nelson–Siegel (AFNS) term structure model, the authors examine how yield curves in the US and China react to exchange rate policy shocks as China introduces gradual reforms to make its exchange rate regime more flexible. The paper aims to discuss this issue. Design/methodology/approach - The authors characterize the specification of the discrete-time AFNS model, prove the uniqueness of the solution for model identification, perform specification analysis on its canonical form and detail the MCMC estimation method with a fast and reliable prior extraction step. Findings - Model decomposition reveals that in the US yield responses, changes in risk premia for medium- to long-term yields dominate changes in yield expectation for short- to medium-term yields, indicating that the portfolio rebalancing effect due to varying risk perception is stronger than the signaling effect due to policy rate expectation. Practical implications - The results are helpful in diagnosing market sentiment and exchange rate risk pricing as China further internationalizes its currency. Originality/value - The methodology can be easily extended to study yield curve responses to other scenarios of policy shocks or regime changes.

Keywords: Arbitrage-free Nelson–Siegel term structure model; Exchange rate risk; Macro-finance; Yield curve; E43; F31 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eme:cfripp:cfri-12-2017-0239

DOI: 10.1108/CFRI-12-2017-0239

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