Correlations between the Market Price of Interest Rate Risk and Bond Yields
DOI:
https://doi.org/10.6000/1929-7092.2017.06.19Keywords:
Correlation analysis, Financial policy-making, Interest rate model, Interest-rate-risk management, Market price of risk, Potential future exposure, Risk premium, Solvency risk, U.S. Treasury yields, Hull-White modelAbstract
This paper examines empirical properties of the market price of interest rate risk, focusing on the relation between the price and interest rates. We briefly summarize how the market price of risk is estimated, and introduce the positive slope model to explain our empirical observation. The market price of risk is estimated for the U.S. Treasury market, 1970-2014, using the Hull–White model. We test the correlation between the market price of interest rate risk and bond yields. The results are that the yield change and term spreads are significantly correlated with the market price of risk, but the initial yields are not correlated with that. These results are theoretically interpreted by a mathematical model, and serve as a valuable reference for risk management as well as for study of financial policy.
References
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Cheridito, Patrick, Damir Filipovi? and Robert L. Kimmel. 2007. ""Market Price of Risk Specifications for Affine Models: Theory and Evidence"", Journal of Financial Economics, 83(1):123-170.
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Musiela, Marek and Marek Rutkowski. 1997. ""Continuous-time Term Structure Models: Forward Measure Approach"", Finance and Stochastics 1:261–291.
https://doi.org/10.1007/s007800050025
Shreve, Steven E. 2004. Stochastic Calculus for Finance II: Continuous-time Models. New York: Springer.
https://doi.org/10.1007/978-1-4757-4296-1
Stanton, Richard. 1997. ""A Nonparametric Model of Term Structure Dynamics and the Market Price of Interest Rate Risk"", J. of Finance, 52:1973-2002.
https://doi.org/10.1111/j.1540-6261.1997.tb02748.x
Yasuoka, Takashi. 2013. ""LIBOR Market Model under the Real-world Measure"", Int. J. Theoretical and Applied Finance, 16(4):1350024(18pages).
Yasuoka, Takashi. 2015a. ""Interest-rate Simulation under the Real-world Measure within a Gaussian HJM Framework"", Quantitative Finance Letters, 3(1):10-16. http://www.tandfonline.com/doi/full/10.1080/21649502.2014.
Yasuoka, Takashi. 2015b. Interest Rate Modeling for Risk Management: Market Price of Interest Rate Risk, Sharjah: Bentham.
Brace, Alan, Dariusz Gatarek and Marek Musiela. 1997. ""The Market Model of Interest Rate Dynamics"", Mathematical Finance 7:127–155.
https://doi.org/10.1111/1467-9965.00028
Cheridito, Patrick, Damir Filipovi? and Robert L. Kimmel. 2007. ""Market Price of Risk Specifications for Affine Models: Theory and Evidence"", Journal of Financial Economics, 83(1):123-170.
https://doi.org/10.1016/j.jfineco.2005.09.008
De Jong, Frank. 2000. ""Time Series and Cross-section Information in Affine Term-structure Models"", Journal of Business & Economic Statistics, 18(3):300-314.
https://doi.org/10.2307/1392263
De Jong, Frank and Pedoro Santa-Clara. 1999. ""The Dynamics of the Forward Interest Rate Curve: A Formulation with State Variables"", Journal of Financial and Quantitative Analysis, 34(01):131-157.
https://doi.org/10.2307/2676249
Duffee, Gregory R. 2002. ""Term Premia and Interest Rate Forecasts in Affine Models"", Journal of Finance, 57(1):405-443.
https://doi.org/10.1111/1540-6261.00426
Heath David, Robert Jarrow and Andrew Morton. 1992. ""Bond Pricing and the Term Structure of Interest Rates: A New Methodology"", Econometrica, 61:77-105.
Hull, John and Alan White. 1990. ""Pricing Interest-rate Derivative Securities"", The Review of Financial Studies, 3:573-592.
https://doi.org/10.1093/rfs/3.4.573
Jamshidian, Farshid. 1997. ""LIBOR and Swap Market Models and Measures"", Finance and Stochastics 1:293–330.
https://doi.org/10.1007/s007800050026
Litterman, Robert and Jose Scheinkman. 1991. ""Common Factors Affecting Bond Returns"", Journal of Fixed Income, 1(1):54-61.
https://doi.org/10.3905/jfi.1991.692347
Munk, Claus. 2011. Fixed Income Modelling. Oxford: Oxford University Press.
https://doi.org/10.1093/acprof:oso/9780199575084.001.0001
Musiela, Marek and Marek Rutkowski. 1997. ""Continuous-time Term Structure Models: Forward Measure Approach"", Finance and Stochastics 1:261–291.
https://doi.org/10.1007/s007800050025
Shreve, Steven E. 2004. Stochastic Calculus for Finance II: Continuous-time Models. New York: Springer.
https://doi.org/10.1007/978-1-4757-4296-1
Stanton, Richard. 1997. ""A Nonparametric Model of Term Structure Dynamics and the Market Price of Interest Rate Risk"", J. of Finance, 52:1973-2002.
https://doi.org/10.1111/j.1540-6261.1997.tb02748.x
Yasuoka, Takashi. 2013. ""LIBOR Market Model under the Real-world Measure"", Int. J. Theoretical and Applied Finance, 16(4):1350024(18pages).
Yasuoka, Takashi. 2015a. ""Interest-rate Simulation under the Real-world Measure within a Gaussian HJM Framework"", Quantitative Finance Letters, 3(1):10-16. http://www.tandfonline.com/doi/full/10.1080/21649502.2014.
Yasuoka, Takashi. 2015b. Interest Rate Modeling for Risk Management: Market Price of Interest Rate Risk, Sharjah: Bentham.
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Published
2017-06-05
How to Cite
Yasuoka, T. (2017). Correlations between the Market Price of Interest Rate Risk and Bond Yields. Journal of Reviews on Global Economics, 6, 208–217. https://doi.org/10.6000/1929-7092.2017.06.19
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Special Issue - Monetary Policy in a Post-Crisis World: Experiences and Practices
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