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Deconstructing the yield curve

Richard Crump () and Nikolay Gospodinov ()

No 884, Staff Reports from Federal Reserve Bank of New York

Abstract: We investigate the factor structure of the term structure of interest rates and argue that characterizing the minimal dimension of the data generating process is more challenging than currently appreciated. As a result, inference procedures for yield curve models that commit to a parsimoniously parameterized factor structure may be omitting important information about the underlying true factor space. To circumvent these difficulties, we introduce a novel nonparametric bootstrap that is robust to general forms of time and cross-sectional dependence and conditional heteroskedasticity of unknown form. We show that our bootstrap procedure is asymptotically valid and exhibits excellent finite-sample properties in simulations. We demonstrate the applicability of our results in two empirical exercises: first, we show that measures of equity market tail risk and the state of the macroeconomy predict bond returns beyond the level or slope of the yield curve; second, we provide a bootstrap-based bias correction and confidence intervals for the probability of recession based on the shape of the yield curve. Our results apply more generally to all assets with a finite maturity structure.

Keywords: term structure of interest rates; factor models; principal components; bond risk premiums; resampling-based inference (search for similar items in EconPapers)
JEL-codes: C15 C58 G10 G12 (search for similar items in EconPapers)
Date: 2019-04-01, Revised 2019-05-01
New Economics Papers: this item is included in nep-ecm and nep-ets
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