Estimating the Premium Implicit in the Yields of Treasury Bills

Abstract

This study examines the variation in the premium implicit in the yield curve of 12-month Treasury Bills during the period 1992–2002. This premium is measured using a number of econometric methods, one of which allows for the estimated premium to react to uncertainty as measured by the variance of the excess forward return. The findings indicate that during the disinflationary process the premium was characterized by a downward trend which corresponded to the decline in the risk of inflation. During the period from the end of 2000 until the end of 2002, the premium increased as a result of the Intifada which began in the last quarter of 2000 and the crisis of confidence in economic policy which characterized the first half of 2002. The study also examines additional factors that influence the premium. Among those found to have a significant influence were the gap between inflation and the inflation target, the interest rate gap between Israel and aboard, the proportion of Treasury Bills held by the public and the Bank of Israel interest rate (and its standard deviation).