Working Paper: NBER ID: w3682
Authors: Robert F. Engle; Victor K. Ng
Abstract: In this paper, we consider a framework with which the cross sectional and time series behavior of the yield curve can be studied simultaneously. We examine the relationship between the yield curve and the time-varying conditional volatility of the Treasury bill market. We demonstrate that differently shaped yield curves can result given different combinations of volatility and expectations about future spot rates. Moreover, adjusting the forward rate for the volatility related liquidity premium can improve its performance as a predictor of future spot rates at least for the period from August 1964 to August 1979.
Keywords: Term Structure; Yield Curve; Volatility; Liquidity Premium; Financial Markets
JEL Codes: G12; E43
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| volatility of the treasury bill market (E43) | yield curve shape (E43) |
| high volatility (C58) | premium component significance (C29) |
| low volatility (G19) | expectation component significance (D84) |
| premium-adjusted forward rates (E43) | forecasts for future spot rates (E47) |