Modeling The Term Structure Of Treasury Yields In China

Term structure is a very important instrument to depict daily change of interestrate. Among different kinds of interest rates, the yield to maturity of one nation’sTreasury bond is viewed as the benchmark for others. Given its lowest possibility todefault, it is always used as risk-free rate in different fields. From the aspects oftrading volume and the participants, the interbank market is so important that theinterest rate information derived from this market will be more persuasive. China’sinterbank market, compared with mature market it is still growing. Therefore there isno consensus on which kinds of model is suitable for Chinese term structure.Firstly we introduce different kinds of model and apply two of them, which areNelson-Siegel Model and Spline Function Model, to fit the curve. In the modelingpart, we use1506daily records (31590transactions from2006/3/1to2012/3/21) tobuild the model simultaneously. Furthermore, different kinds of criteria (MSE, MAPEand MAD) will be used to select a better one. The result illustrates the SplineFunction Model is better to fit the curve.Secondly, we extract the10year interest rate from the model and try to explainthe trend of long-term interest rate with economic situation at each year.Thirdly, based on previous research, we apply principal component analysis onour result and abstract the change of term structure by three factors (level, slope andcurvature). Next we check the explanatory power of these factors for the change ofterm structure. The result shows these factors can explain94%total change.Forth, we select four factors representing consumers, enterprises, governmentand market itself and apply VAR model to examine how much influence four factorsmake on the interest rate. According to the impulse response function and variancedecomposition, three factors illustrate little impact on macro factors, and macrofactors appear influence on the shape of term structure.