Yield Curve and Financial Uncertainty: Evidence Based on US Data

Abstract

How do short-and long-term interest rates respond to a jump in financial uncertainty? We address this question by conducting a local projections analysis with US monthly data, period: 1962-2018. The state-of-the-art financial uncertainty measure proposed by Ludvigson, Ma and Ng (2019) is found to predict movements in interest rates at different maturities. In particular, an increase in financial uncertainty is found to trigger a negative and significant response of both short-and long-term interest rates. The response of the short end of the yield curve (i.e., of short-term interest rates) is found to be stronger than that of the long end (i.e., of longterm ones). In other words, a financial uncertainty shock causes a temporary steepening of the yield curve. This result is consistent, among other interpretations, with medium-term expectations of a recovery in real activity after a financial uncertainty shock.

On the aggregate effects of global uncertainty: Evidence from an emerging economy

“…Theoretically, the impact of uncertainty shock on inflation is generated via two opposing channels: the upward pricing bias channel which results into price increases by firms and the aggregate demand channel that tends to reduce inflation due to economic slackness (Fern andez-Villaverde et al, 2015). The finding of this paper is consistent with the results reported by Castelnuovo (2019) and the related studies cited therein. The response of inflation may be explained by the observation in New-Keynesian models (e.g.…”

Uncertainty before and during COVID‐19: A survey

“…They find the risk-management-driven policy rate gap to be as large as 75 basis points (equivalent to three standard policy moves by the Federal Reserve) in correspondence with financial volatility-triggering events such as the Black Monday and the 2008 credit crunch. Castelnuovo (2019) estimates the response of the US yield curve to a change in US financial uncertainty as proxied by the financial uncertainty measure constructed by Ludvigson et al (2021b). He finds both short-and long-term rates to temporarily decrease, with the yield curve steepening in the short run before going back to its pre-shock slope.…”

Uncertainty and the Term Structure of Interest Rates

“…In this paper we investigate how the term structure reacts to unexpectedly heightened uncertainty of various forms. Our investigation is motivated by the desire of market participants and policy makers to understand the drivers of yield curve dynamics, together with a vast literature that nds various types of uncertainty have notoriously contractive macroeconomic eects (e.g., Bloom, 2009;Mumtaz and Zanetti, 2013;Jurado et al, 2015), and a burgeoning literature exploring how uncertainty impacts the term structure (Castelnuovo, 2019;Tillmann, 2020;Hansen et al, 2019;Shang, 2022). 1 Using local projections regressions, Castelnuovo (2019) nds that heightened nancial uncertainty reduces both short-and long-term interest rates.…”

“…Our investigation is motivated by the desire of market participants and policy makers to understand the drivers of yield curve dynamics, together with a vast literature that nds various types of uncertainty have notoriously contractive macroeconomic eects (e.g., Bloom, 2009;Mumtaz and Zanetti, 2013;Jurado et al, 2015), and a burgeoning literature exploring how uncertainty impacts the term structure (Castelnuovo, 2019;Tillmann, 2020;Hansen et al, 2019;Shang, 2022). 1 Using local projections regressions, Castelnuovo (2019) nds that heightened nancial uncertainty reduces both short-and long-term interest rates. Tillmann (2020) and Shang (2022) use distinct term-structure models with uncertainty interactions to independently show that high uncertainty about monetary policy decreases the central banks ability to impact the term structure.…”