The Central Tendency: A Second Factor in Bond Yields

26 Pages Posted: 26 Oct 1995

See all articles by Silverio Foresi

Silverio Foresi

Goldman Sachs Group, Inc. - Quantitative Strategy Group

Pierluigi Balduzzi

Boston College - Carroll School of Management

Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business

Multiple version iconThere are 6 versions of this paper

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

Foresi, Silverio and Balduzzi, Pierluigi and Das, Sanjiv Ranjan, The Central Tendency: A Second Factor in Bond Yields (July 1996). Available at SSRN: https://ssrn.com/abstract=2251 or http://dx.doi.org/10.2139/ssrn.2251

Silverio Foresi (Contact Author)

Goldman Sachs Group, Inc. - Quantitative Strategy Group ( email )

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Pierluigi Balduzzi

Boston College - Carroll School of Management ( email )

Department of Finance
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HOME PAGE: http://www.bc.edu/bc_org/avp/csom/faculty/

Sanjiv Ranjan Das

Santa Clara University - Leavey School of Business ( email )

Department of Finance
316M Lucas Hall
Santa Clara, CA 95053
United States

HOME PAGE: http://srdas.github.io/