The Dynamics Of Term Structrue Of Interest Rates

The term structure of interest rates, known as yield curve, describes how bondyields change with different maturities, and reflects the cost of borrowing in thefinancial market. This thesis put focus on two key concerns about term structure: first,what are the dynamic features of term structure of interest rates in China bond market?Second, what drive(s) the term structure of interest rates to evolve within maturitiesand across time? Due to the historical reason, there are two different secondary bondmarkets in China, that is, the security market and the inter-bank market. The monthlybond yields dataset in this thesis is from both markets, ranging from Jan2005to Dec2012. But maturities are not the same, from1year to20years in security marketwhile from1year to30years in inter-bank market. In chapter3the dynamiccharacteristics of term structure are investigated. Main findings include:(i) themovement of term structure is closely related to the monetary policies according tothe patterns it shows, especially in inter-bank market;(ii) statistically speaking, theaverage yields of Chinese government bonds go up gradually with the maturityincreasing, which means the term structure of average interest rates slpe up;(iii) bondyields present a highly persistence, and its conditional volatility is time varying, butthe dependence on the yields’ level, as well as the autocorrelation, is not significant;(iv) the three principal components-level, slop and curvature, almost account for allthe variation of bond yields and fit well the data in cross section.Expectations Hypothesis provides an explanation for the movement of termstructure of interest rates, so it has been in the center of bond pricing theory andpractice. Chapter4employs the method in Cochrane and Piazzesi (2005) to test theExpectations Hypothesis. The target is to check whether the classic hypothesis couldfully explain the dynamic movement of term structure. Basic conclusions are asfollows: the estimated coefficients of forward rates show an S shape with bothpositives and negatives, instead of a tent shape in CP original paper; under therestriction, the estimated coefficients by the two step procedure are consistent withthe unrestricted counterparts to some extents. Because the excess bond returns arepredicted by the CP factor significantly, which computed by a linear combination offorward rates, the Expectations Hypothesis cannot fully account for the movement ofterm structure. Chapter5investigates the dynamic term structure of interest rates based on theNelson-Siegel class model and the impacts of macroeconomic variables on the termstructure of interest rates. We employ a two-step optimization approach to estimatethe dynamic parameters of the Nelson-Siegel family models (NS, DL, NSS and ANSSmodel), compare the fitness of the models, and finally examine the impacts of themacroeconomic variables on the latent factors of the term structure based on theoptimal mode. The results show that the dynamic NS model fits the data best fromChina’s bond markets among the Nelson-Siegel family models. The GDP growth rate,PPI growth rate, M2growth rate, as well as one-year interest rate have significanteffects on the level and slope factors while the PPI growth rate, M2growth rate, andthe one-year interest rate have significant effects on the curvature factor of the termstructure. The PPI growth rate is the most important factor that has impact on thelevel factor while PPI growth rate and one-year interest rate are the most importantdeterminants of the slope and curvature factors.