Extended Discrete-time No-arbitrage Nelson-Siegel Interest Rate Term Structure Model And Its Applications In Macro-finance

Since Treasury yield curve is the pricing benchmark of financial market,the regulator of macro-economic and the barometer of the national sovereign credit risk,the studies of Treasury yield curve,including the model theories development and empirical ap-plications,have widely attracted the attention of scholars and and financial institutions all over the world.In this paper,we first establish an AFNS mixed factor model based on the discrete-time AFNS model,which is a generalized extension of spanned and unscanned models.Then,we study three different practical problems of domestic and foreign government bond markets under this framework.First of all,China’s local government debt financing grows rapidly since the glob-al financial crisis in 2008,featuring surging exposure of local government debt risk.The accumulation of local government debt poses systemic risks to China’s fiscal and financial systems.Using weekly data from 2009 to 2014,this paper studies the joint dynamics of a relatively market-oriented local debt risk factor,i.e.,the chengtou bond spreads,and Treasury yields under the framework of the extended no-arbitrage Nelson-Siegel term structure model,in which the risk transmission mechanism between local risk and Treasury yields can be investigated.The results show that the local government debt risk affects the Treasury bonds through two channels:1)"substitution effect",i.e.,as the safest asset in China,the Treasury bonds with short-to-medium maturities en-joy a "fly-to-safety" effect with decreasing yields when the local government debt risk increases;2)"compensation effect",i.e.,the local government debt risk may lead to systemic risk of the Treasury bonds that the Treasury yields contain a significant com-ponent of risk premium due to local debt risk.Though the empirical results show that the "substitution effect" dominates the "compensation effect" within the sample peri-od up to 2014,we still need to pay attention to local debt risk in real time to monitor potential outbreak of systemic risks.Secondly,combining the inflation expectation term structure constructed by sur-vey data,we extract the inflation expectation,inflation risk premia and market liquidity factor from the Treasury bond market and the TIPS market and further analyze the dynamics relationship between factors and how the factors affect the inflation expec-tation.The empirical result shows that the market inflation expectation extracted by our model successfully heals the distortions caused by the huge liquidity difference be-tween markets during crisis and has similar level and dynamics with the survey data,which provides efficient information for policy makers making decisions.Besides,we find that the extracted liquidity factor somehow reflects the liquidity of the whole mar-ket and significantly improves the explanatory of yield spread between corporate bond yield and Treasury yield,which is useful for liquidity and credit risk decompositions for corporate bonds.Further more,the impulse response and variance decomposition show that the yield factors contribute a lot of the variance of inflation expectation,which implies that attention and regulation of the yield curve changes can help make accurate judgments and reasonable adjustments to the macroeconomic for monetary policy makers.Finally,this paper investigates,within a no-arbitrage multi-country framework,the impact of the euro area sovereign credit risks of periphery countries on their own yield curves and on the euro area benchmark,the German yield curve.The results show that Germany,though as the strongest economy in the euro zone,its yield curve also affected by the sovereign credit risk of neighboring countries during the European debt crisis.Specifically,the common factor lowers the curvature factor and the individual factor of Spain lifts the level factor;individual factor of Italy lowers the short-term yield of Germany but has positive factor loading on its short-term risk premia while individual factor of Greece pushes the short-term yield of Germany up.Besides,we find that the dynamics and variance contribution between factors are time-varying.The results are useful for the European policy makers to assess the severity and market expectation on the debt crisis.