Profiting from Mean-Reverting Yield Curve Trading Strategies

Krishna Ramaswamy (), Choong-Tze Chua and Winston Koh

No 142, Econometric Society 2004 Australasian Meetings from Econometric Society

Abstract: A large class of fixed income trading strategies focuses on opportunities offered by the interest rate term structure. This paper studies a set of yield curve trading strategies that are based on the view that the yield curve mean-reverts to an unconditional curve. These mean-reverting trading strategies exploit deviations in the level, slope and curvature of the yield curve from historical norms. We consider cash-neutral trades with one-month holding periods. Some mean-reverting strategies were found to be highly profitable, and outperform, on a risk-adjusted basis before transaction costs, alternative strategies of an investment in the Lehman Brothers Bond index (by up to 5.9 times) and an investment in the S&P index (by up to 5.1 times). Even after accounting for transaction costs, some of these strategies are still significantly more profitable than the benchmarks. Furthermore, transaction costs can be reduced substantially by changing the trading frequency or through structured derivative trades. We found evidence that market efficiency has improved, and the scope for excess returns has diminished since the late 1980s

Keywords: yield curve; fixed income trading; market efficiency; Treasury bonds (search for similar items in EconPapers)
JEL-codes: G14 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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