An Empirical Investigation of the Level Effect in Australian Interest Rates

Abstract

An extensive literature examines the dynamics of interest rates, with particular attention given to the positive relationship between interest-rate volatility and the level of interest rates-the so-called level effect. This paper examines the interaction bet^'een the estimated level effect and competing parameterisations of interest-rate volatility for the Australian yield curve. We adopt a new methodology that estimates elasticity in a multivariate setting that explicitly accommodates the correlations that exist between various yield factors. Results show that significant correlations exist betM>een the residuals of yield factors and that such correlations do indeed impact on model estimates. Within the multivariate setting, the level of the short rate is shown to be a crucial determinant of the conditional volatility of all three yield factors. Measures of model fit suggest that, in addition to the usual level effect, the incorporation of GARCH effects and possible regime shifts is important.

The Subprime Mortgage Meltdown

“…Here, Gray and Smith (2008) continue this research, applied to the Australian yield curve. They adopt a new estimation technique that shows that significant correlations exist between the residuals of such parameters of the yield curve as level, slope, and curvature, at least for short-term rates.…”

Measuring monetary policy expectations

“…We apply this approach to examine market pricing in Australia for policy movements over horizons of up to three years, in contrast to the vast majority of the literature on market-based measures of policy expectations (with the exception of Goodhart and Lim (2011), who examine short-to medium-term policy expectations priced into the United Kingdom interest rate swap curve and government bond curve). While extant studies of Australian interest rates have focused on term premia (Guido and Walsh, 2005;Walsh and Tan, 2008), yield curve forecasting (Bilson et al, 2008) and the short-rate process (Chan, 2005;Gray, 2005;Gray and Smith, 2008;Sanford and Martin, 2006;Gray, 2003, 2006), our work constitutes the first empirical examination of policy expectations in the Australian fixed-income market. In particular, our approach complements the literature on estimating and forecasting the policy rate according to the short-rate process by incorporating information from many different classes of fixed-income securities, whose tenors span the entire yield curve.…”

Bond pricing with a surface of zero coupon yields

“…Given our focus on Australian dollar denominated semi‐government, SSA bonds, our work addresses an important gap in the Australian fixed income literature. To date, researchers have concentrated predominantly on the Australian short rate (Treepongkaruna and Gray, 2003, 2006; Chan, 2005; Gray, 2005; Sanford and Martin, 2006; Gray and Smith, 2008), the sovereign Commonwealth Government bond market (Bilson et al. , 2008; Finlay and Jones, 2011), the Australian Dollar interest rate swap market (Fang and Muljono, 2003; In et al.…”