Understanding the Real Rate Conundrum: An Application of No-Arbitrage Models to the UK Real Yield Curve

Michael A. S. Joyce, Iryna Kaminska and Peter Lildholdt

Review of Finance, 2011, vol. 16, issue 3, 837-866

Abstract: During 2004 and 2005, long-horizon interest rates fell sharply in major international government bond markets (Greenspan's "conundrum"). This common fall mainly reflected lower long real rates. To investigate possible causes, the authors apply a no-arbitrage affine modeling framework to understanding the UK real term structure. The authors find that time-varying term premia are important in explaining movements in long real forward rates. And, although there is evidence that long-horizon expected short real rates declined over the conundrum period, the authors' results suggest that lower term premia played the dominant role. This could be consistent with the so-called "search for yield" and excess liquidity explanations for the conundrum. Copyright 2011, Oxford University Press.

Date: 2011
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