What Does Yield Curve Smoothness Mean?

45 Pages Posted: 14 Nov 2004

See all articles by Vincent Brousseau

Vincent Brousseau

European Central Bank, Directorate General Economics

Benjamin Sahel

European Central Bank

Date Written: August 28, 2001

Abstract

The degree of smoothness of interest rates alongside the maturity spectrum can provide indications regarding the degree of "arbitrage trading activity" in interest rate markets, which in turn may be related, to some extent, to market expectations, risk aversion and market liquidity. We present two main applications of smoothness indicators. First, using tick data for the money market of the euro we show that fluctuations in smoothness in a very liquid market reflect some changes in the pattern of risk aversion amongst market participants. Second, we compare developments in smoothness in government bond markets across five countries (Germany, Spain, France, Japan and the United States). Amongst various results, we find that the degree of smoothness declines in periods of heightened financial market volatility and liquidity dry-ups. In particular, smoothness was low in the United States, Japan and France during the episode of financial market turbulence of the autumn of 1998.

Keywords: Term structure of interest rates, yield curve, market liquidity, market microstructure, and public debt management

JEL Classification: E43, G63

Suggested Citation

Brousseau, Vincent and Sahel, Benjamin, What Does Yield Curve Smoothness Mean? (August 28, 2001). Available at SSRN: https://ssrn.com/abstract=550741 or http://dx.doi.org/10.2139/ssrn.550741

Vincent Brousseau (Contact Author)

European Central Bank, Directorate General Economics ( email )

Kaiserstrasse 29
Frankfurt am Main, 60311
Germany
0049 69 13440 (Phone)
0044 69 1344 6000 (Fax)

Benjamin Sahel

European Central Bank ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany