The Central Tendency: A Second Factor in Bond Yields
26 Pages Posted: 26 Oct 1995
There are 6 versions of this paper
The Central Tendency: A Second Factor in Bond Yields
The Central Tendency: A Second Factor in Bond Yields
The Central Tendency: A Second Factor in Bond Yields
The Central Tendency: A Second Factor in Bond Yields
The Central Tendency: A Second Factor in Bond Yields
The Central Tendency: A Second Factor in Bond Yields
Date Written: July 1996
Abstract
In one-factor models, such as Cox, Ingersoll, and Ross (1985) or Vasicek (1977), the conditional mean of the instantaneous rate changes with its current level. This paper gathers evidence that the conditional mean of the one- month rate explains variations in bond yields of different maturities, even after controlling for the effect of the current level of the one-month rate. This suggests the presence of a second factor driving the conditional mean, other than the level of the one-month rate: we refer to this second factor as the central tendency. The above idea is captured in a two-factor model of the term structure where the instantaneous rate fluctuates around a stochastic central tendency. We then build a proxy for the central- tendency factor based on the information contained in the term structure of interest rates. We use the proxy to estimate the process for the one-month rate, and find the central-tendency proxy to be significant in explaining the conditional mean of the one-month rate.
JEL Classification: E43, G12
Suggested Citation: Suggested Citation
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