Level, slope, curvature of the sovereign yield curve, and fiscal behaviour

Abstract

4 Non-technical summary 5

Applying a macro-finance yield curve to UK quantitative Easing

“…We assume that the forecasted path is the counterfactual path of interest rates that would have occurred if QE had not been employed by the Bank of England. 4 Our out-of-sample forecast are similar in size to other recent literature on the …rst round of QE in the UK such as Caglar et al (2012) and Meaning and Zhu (2012) with the …ve year forward and the ten year forward on average overestimating the actual curve by 60-70 and 40-50 basis points respectively. We …nd the overestimate of nominal forward rates is plausible both in terms of timing and maturities targeted: the overestimate occurs from March 2009 and maturities greater than 24 months show an over-prediction relative to the actual curve.…”

“…The literature often focuses on the three macroeconomic variables that are associated with monetary policy: in ‡ation, real output and the policy interest rate. In recent years research has started to extend beyond these variables, such as Afonso and Martins (2012) who study the e¤ects of …scal variables on the term structure or Dewachter and Iania (2011) on the e¤ects of …nancial variables. Whilst the number of macroeconomic variables used to explain yield curve dynamics in a¢ ne models remain quite limited.…”

“…2 In total we examine 31 di¤erent macroeconomic variables over …ve key groups of data: in ‡ation, real activity, monetary and …scal policy, …nancial prices and international factors. The estimation is performed in two stages; …rstly adopting the state space methodology similar to that of and Afonso and Martins (2012). We estimate a variant of NelsonSiegel, which is Svensson's four factor model (1994, henceforth referred to as Svensson), for the forward curve for both the UK nominal and real term structures using a Kalman …lter and maximum likelihood estimation.…”

The financial market impact of UK quantitative easing

“…At the MPC meeting of 4 February 2010, it was decided not to increase the stock of APF assets any further, and thus QE was e¤ectively temporarily suspended as the programme of asset purchases was by then complete until QE was re-introduced in October 2011. 3 . Figure 2 traces the impact of QE by examining gilt holdings by sector.…”

“…The …rst stage involves putting the term structure into a the functional form proposed by Svensson (1994). We employ an approach similar to that of Diebold et al (2006) and Afonso and Martins (2010), obtaining four latent factors-level, slope and two curvatures-by means of the Kalman …lter. The second step is to relate these latent factors to a representative set of macroeconomic variables through a SUR regression.…”