Global Yield Curve Dynamics and Interactions: A Dynamic Nelson-Siegel Approach

Abstract

The popular Nelson-Siegel (1987) yield curve is routinely fit to cross sections of intra-country bond yields, and Diebold and Li (2006) have recently proposed a dynamized version. In this paper we extend Diebold-Li to a global context, modeling a potentially large set of country yield curves in a framework that allows for both global and country-specific factors. In an empirical analysis of term structures of government bond yields for the Germany, Japan, the U.K. and the U.S., we find that global yield factors do indeed exist and are economically important, generally explaining significant fractions of country yield curve dynamics, with interesting differences across countries.

International evidence on bond risk premia

“…I find that CP factors exhibit considerably less common variation than yields and forward rates. Contrary to the more traditional yield curve factors of slope and curvature, whose dynamics have been shown by Diebold et al (2008) to be greatly influenced by global factors, CP factors seem to be driven more strongly by country idiosyncratic factors.…”

“…doi:10.1016/j.jbankfin.2010.07.029 their respective monthly excess returns from January 1978 to June 1993. Diebold et al (2008) fitted yield curve data for Germany, Japan, the United Kingdom, and the United States to study a global yield curve model, 3 where the dynamics of yields depend on local and global factors. They find that global yield curve factors explain a significant portion of a country's yield curve level and slope.…”

Varying risk premia in international bond markets

“…Comparing the market price of a bond today with its predicted price gives a bond return forecast. Diebold and Li (2006), , Diebold et al (2007) and Ang and Piazzesi (2003) follow this approach. Articles in the second category do not take the detour via the yield curve forecast, but predict bond returns directly.…”

When and how US dollar shortages evolved into the full crisis? Evidence from the cross-currency swap market

“…As for the first issue, Menkveld et al (2007) develop a general methodology to study price discovery for cross-listed stocks by estimating the efficient price (fundamental common factor) under the state space model. Diebold et al (2008) also propose a state space model to extract the common factor from yield curves in major countries.…”

“…Here, following Diebold et al (2008), we make the following two identifying assumptions. First, we assume that the standard deviation of innovations to the common factor is 1 (r m = 1) because the magnitude of the common factor and factor loadings b(s) are not separately identifiable.…”