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The Central Tendency: A Second Factor In Bond Yields

Pierluigi Balduzzi, Sanjiv Das () and Silverio Foresi

The Review of Economics and Statistics, 1998, vol. 80, issue 1, 62-72

Abstract: We assume that the instantaneous riskless rate reverts toward a central tendency which, in turn, is changing stochastically over time. As a result, current short-term rates are not sufficient to predict future short-term rate movements, as it would be the case if the central tendency were constant. However, since longer maturity bond prices incorporate information about the central tendency, longer maturity bond yields can be used to predict future short-term rate movements. We develop a two-factor model of the term structure which implies that a linear combination of any two rates can be used as a proxy for the central tendency. Based on this central-tendency proxy, we estimate a model of the one-month rate that performs better than models which assume the central tendency to be constant. © 1998 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology

Date: 1998
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Working Paper: The Central Tendency: A Second Factor in Bond Yields (1997) Downloads
Working Paper: The Central Tendency: A Second Factor in Bond Yields (1996)
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The Review of Economics and Statistics is currently edited by Amitabh Chandra, Olivier Coibion, Bryan S. Graham, Shachar Kariv, Amit K. Khandelwal, Asim Ijaz Khwaja, Brigitte C. Madrian and Rohini Pande

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