In this thesis, I study the transmission of monetary policy through the term structure of interest rates. This is an important topic because, with short-term nominal interest rates in many advanced economies close to their effective lower bound since 2008-2009, central banks have used `unconventional' monetary policies, such as large-scale asset purchases and forward guidance, to stimulate macroeconomic activity by, inter alia, placing downward pressure on longer-term interest rates. I focus on the mechanisms through which monetary policy influences bond yields, domestically and globally, with reference to a canonical decomposition of longer-term interest rates into expectations of future short-term interest rates, and term premia. After an introduction in chapter 1, chapter 2 appraises the use of overnight indexed swap (OIS) rates as measures of expected future monetary policy. Unlike federal funds futures (FFFs), which have regularly been used to construct measures of US interest rate expectations, OIS rates are available in many countries. I find that US OIS rates provide measures of interest rate expectations that are as good as those from FFFs, and that US, UK, Eurozone and Japanese OIS rates up to a 2-year horizon tend to accurately measure interest rate expectations, providing comparable cross-country measures of monetary policy expectations. In chapter 3, I propose a novel method for estimating interest rate expectations and term premia at short and long-term horizons: a no-arbitrage Gaussian affine dynamic term structure model (GADTSM) augmented with OIS rates. Using 3 to 24-month OIS rates, the OIS-augmented model generates estimates of the expected path of short-term interest rates out to a 10-year horizon that closely correspond to those implied by FFFs rates and survey expectations, outperforming existing GADTSMs. I study the transmission of US unconventional monetary policies in chapter 4. Using the OIS-augmented GADTSM, I carry out an event study to demonstrate that US unconventional monetary policy announcements between November 2008 and April 2013 did significantly reduce US longer-term interest rates by affecting expectations and term premia. As a result of these declines, unconventional monetary policies aided US real economic outcomes. Using a structural vector autoregression, I show that changes in interest rate expectations, linked to monetary policy signalling, had more expansionary effects on US real economic outcomes than changes in term premia, associated with portfolio rebalancing. Chapter 5 assesses the international transmission of monetary policy through the term structure of interest rates between advanced economies. I present a micro-founded, two-country model with endogenous portfolio choice amongst country-specific short and long-term bonds, and equity. Within the model, US monetary policy has sizeable effects on longer-term interest rates in other advanced economies, which are similar to empirical estimates. Using the OIS-augmented GADTSM in an event study, I show that US monetary policy has led to changes in interest rate expectations in other advanced economies that amplify global spillovers, which have been partly mitigated by changes in term premia through portfolio rebalancing.

L'objet de cette thèse est l'étude d'un modèle de la dynamique de la courbe de taux d'intérêt pour la valorisation et la gestion des produits dérivées. En particulier, nous souhaitons modéliser la dynamique des prix dépendant de la volatilité. La pratique de marché consiste à utiliser une représentation paramétrique du marché, et à construire les portefeuilles de couverture en calculant les sensibilités par rapport aux paramètres du modèle. Les paramètres du modèle étant calibrés au quotidien pour que le modèle reproduise les prix de marché, la propriété d'autofinancement n'est pas vérifiée. Notre approche est différente, et consiste à remplacer les paramètres par des facteurs, qui sont supposés stochastiques. Les portefeuilles de couverture sont construits en annulant les sensibilités des prix à ces facteurs. Les portefeuilles ainsi obtenus vérifient la propriété d’autofinancement / This PhD thesis is devoted to the study of an Affine Term Structure Model where we use Wishart-like processes to model the stochastic variance-covariance of interest rates. This work was initially motivated by some thoughts on calibration and model risk in hedging interest rates derivatives. The ambition of our work is to build a model which reduces as much as possible the noise coming from daily re-calibration of the model to the market. It is standard market practice to hedge interest rates derivatives using models with parameters that are calibrated on a daily basis to fit the market prices of a set of well chosen instruments (typically the instrument that will be used to hedge the derivative). The model assumes that the parameters are constant, and the model price is based on this assumption; however since these parameters are re-calibrated, they become in fact stochastic. Therefore, calibration introduces some additional terms in the price dynamics (precisely in the drift term of the dynamics) which can lead to poor P&L explain, and mishedging. The initial idea of our research work is to replace the parameters by factors, and assume a dynamics for these factors, and assume that all the parameters involved in the model are constant. Instead of calibrating the parameters to the market, we fit the value of the factors to the observed market prices. A large part of this work has been devoted to the development of an efficient numerical framework to implement the model. We study second order discretization schemes for Monte Carlo simulation of the model. We also study efficient methods for pricing vanilla instruments such as swaptions and caplets. In particular, we investigate expansion techniques for prices and volatility of caplets and swaptions. The arguments that we use to obtain the expansion rely on an expansion of the infinitesimal generator with respect to a perturbation factor. Finally we have studied the calibration problem. As mentioned before, the idea of the model we study in this thesis is to keep the parameters of the model constant, and calibrate the values of the factors to fit the market. In particular, we need to calibrate the initial values (or the variations) of the Wishart-like process to fit the market, which introduces a positive semidefinite constraint in the optimization problem. Semidefinite programming (SDP) gives a natural framework to handle this constraint

[pt] O objeto desta dissertação é desenvolver um modelo baseado em técnicas de simulação e árvore binomial para valorar uma opção de compra européia sobre um contrato futuro. Os modelos diferem na abordagem da estimação de parâmetros e principalmente na estrutura de geração das taxas futuras. O modelo Black, Derman & Toy utiliza árvore binomiais para construir possibilidades futuras de exercício da opção. Este modelo é classificado de não arbitragem porque utiliza a estrutura a termo da taxa de juros como informação inicial para precificar derivativos de taxa de juros como títulos. O modelo de Vasicek é classificado como modelo de equilíbrio porque assume que o processo estocástico da taxa de juros possui um fator comum de incerteza simulada pelo método de Monte Carlo. A ferramenta será fundamentada na teoria de derivativos e processos estocásticos para simular o comportamento do ativo objeto. O trabalho a ser desenvolvido enfoca um modelo de um fator, no qual toda a estrutura a termo da taxa de juros é explicada pela evolução da taxa de juros spot. / [en] The object of this work is to develop a model based on techniques of simulation and binomial tree to valuate a call option over a future contract. The tool will be based on the theory of derivatives and stochastic processes to simulate the behavior of the active object. The model Black, Derman & Toy uses binomial tree to construct future possibilities of exercise of the option. This model is classified of not arbitration because it uses the yeld curve as initial information to valuate derivatives of interests. The model of Vasicek is classified as balance model because it assumes that the random process of the tax of interests has one factor of uncertainty simulated for the Monte method Carlo. The work developed is a model of one factor which all the structure the term of the tax of interests is explained by the evolution of the tax of interests spot.

The purpose of this thesis is to examine the nonlinear relationships between financial (and economic) variables within the field of financial econometrics. The thesis comprises two reviews of literatures, one on nonlinear time series models andthe other one on term structure of interest rates, and four empirical essays on financialapplications using nonlinear modelling techniques. The first empirical essay compares different model specifications of a Markov switching CIR model on the term structure of UK interest rates. We find the least restricted model provides the best in-sample estimation results. Although models with restrictive specifications may provide slightly better out-of-sample forecasts in directional movements of the yields, the economic gains seem to be small. In the second essay, we jointly model the nominal and real term structure of the UK interest rates using a three-factor essentially affine no-arbitrage term structure model. The model-implied expected inflation rates are then used in the subsequent analysis on its nonlinear relationship with the FTSE 100 index return premiums, utilizing a smooth transition vector autoregressive model. We find the model implied expected inflation rates remain below the actual inflation rates after the independence of the Bank of England in 1997, and the recent sharp decline of the expected inflation rates may lend support to the standing ground of the central bank for keeping interest rates low. The nonlinearity test on the relationship between the FTSE 100 index return premiums and the expected inflation rates shows that there exists a nonlinear adjustment on the impact from lagged expected inflation rates to current return premiums. The third essay provides us additional insight into the nature of the aggregate stock market volatilities and its relationship to the expected returns, in a Markov switching model framework, using centuries-long aggregate stock market data from six countries (Australia, Canada, Sweden, Switzerland, UK and US). We find that the Markov switching model assuming both regime dependent mean and volatility with a 3-regime specification is capable to captures the extreme movements of the stock market which are short-lived. The volatility feedback effect that we studied on each of these six countries shows a positive sign on anticipating a high volatility regime of the current trading month. The investigation on the coherence in regimes over time for the six countries shows different results for different pairs of countries. In the last essay, we decompose the term premium of the North American CDX investment grade index into a permanent and a stationary component using a Markov switching unobserved component model. We explain the evolution of the two components in relating them to monetary policy and stock market variables. We establish that the inversion of the CDX index term premium is induced by sudden changes in the unobserved stationary component, which represents the evolution of the fundamentals underpinning the risk neutral probability of default in the economy. We find strong evidence that the unprecedented monetary policy response from the Fed during the crisis period was effective in reducing market uncertainty and helped to steepen the term structure of the CDX index, thereby mitigating systemic risk concerns. The impact of stock market volatility on flattening the term premium was substantially more robust in the crisis period. We also show that equity returns make a significant contribution to the CDX term premium over the entire sample period.

A popular class of yield curve models is based on the Nelson and Siegel (1987) (hereafter NS) approach of fitting yield curve data with simple functions of maturity. However, NS models are not theoretically consistent and they also lack an economic foundation, which limits their wider application in finance and economics. This thesis derives an intertemporally-consistent and arbitrage-free version of the NS model, and provides an explicit macroeconomic foundation for that augmented NS (ANS) model. To illustrate the general applicability of the ANS model, it is then applied to four distinct topics spanning finance and economics, each of which are active areas of research in their own right: i.e (1) forecasting the yield curve; (2) investigating relationships between the yield curve and the macroeconomy; (3) fixed interest portfolio management; and (4) investigating the uncovered interest parity hypothesis (UIPH). In each application, the ANS model allows the formal derivation of a parsimonious theoretical framework that captures the essence of the topic under investigation and is readily applicable in practice. Respectively: (1) the intertemporal consistency embedded in the ANS model results in a vector-autoregressive equation that projects the future yield curve from the current yield curve, and forecasts from that model outperform the random-walk benchmark; (2) the economic foundation for the ANS model leads to a single-equation relationship between the current shape of the yield curve and the magnitude and timing of future output growth, and empirical estimations confirm that the theoretical relationship holds in practice; (3) the ANS model provides a theoretically-consistent framework for quantifying risk and returns in fixed interest portfolios, and portfolios optimised ex-ante using that framework outperform a passive benchmark; and (4) the ANS model allows interest rates to be decomposed into a component related to economic fundamentals in the underlying economy, and a component related to cyclical influences. Empirical tests based on the fundamental interest rate components do not reject the UIPH, while the UIPH is rejected based on the cyclical interest rate components. This provides empirical support for suggestions in the theoretical literature that interest rate and exchange rate dynamics associated with cyclical interlinkages between the economy and financial markets under rational expectations may contribute materially to the UIPH puzzle.

This thesis consists of three self-contained papers covering different aspects of public debt management. From a methodological point of view they all have in common that results and models from the theory of finance are used to analyze the effects of public debt management. The first paper, Neutrality of Public Debt Management, studies the case when public debt management does not matter, i.e. when it is neutral. Although strong assumptions are needed to ensure neutrality of public debt management it is nevertheless of interest to study it, since an analysis illuminates the mechanisms through which public debt management affects the economy. The paper starts with a discussion of the assumptions that are needed to ensure neutrality in the models used in the literature. The remainder of the paper tries to relax some of these assumptions. The model employed is an intertemporal general equilibrium model. It is shown that if the agents are identical, public debt is neutral provided the agents pierce the veil of government, and all taxes associated with public debt are lump-sum. It is also shown that if the agents are different but have sufficiently similar utility functions that exhibit hyperbolic absolute risk aversion (i.e., the agents have linear risk tolerance), public debt management is neutral in aggregates, provided the agents pierce the veil of government and all taxes associated with the debt service are lump-sum. This means that public debt management neither affects prices nor aggregate consumption; it might, however affect the individual agent’s consumption-savings decision. Since the class of utility functions that exhibit hyperbolic absolute risk aversion is widely used in economic analysis, this result has several theoretical and empirical implications. The result also has implications for the choice of model in the third paper of the thesis. The second paper, Objectives of Public Debt Management, discusses the objectives of public debt management in an atemporal mean-variance framework. The model employed in this paper differs in one important aspect from the ones previously used in the literature; it takes the firms’ investment decisions into account and hence endogenizes the supply of assets to some extent. It is shown that if the firms’ behavior is introduced, objectives that in the literature have been assumed to stimulate the economic activity do not necessarily have the desired effect. The paper also discusses different objectives aiming at welfare-improvements and economic stimulation. Since the analysis is performed in a unified framework, it is possible to compare the objectives and to discuss their welfare implications. Of particular interest is the welfare aspects of minimization of the costs of public debt. Finally, the paper also discusses the effectiveness of the objectives and it is shown that with one exception, cost minimization, effectiveness declines when the government-issued debt instruments’ share of the asset market falls. The last paper, Public Debt Management and the Term Structure of Interest Rates, develops and uses a stochastic overlapping generations model to analyze the impact of public debt management on the term structure of interest rate. In most of the literature public debt management is thought of as changes in the maturity structure of the outstanding public debt. A change in the maturity structure implies that public debt management affects, e.g., future tax liabilities and hedging opportunities. To capture these effects it is necessary to use an intertemporal framework. In contrast to most models in the literature on public debt management, the model in this paper is intertemporal and takes the general equilibrium effects of public debt management into account, by integrating the financial and real sectors of the economy. This means that current and future asset prices, as well as investments are affected by public debt management. The analysis suggests that it is not the quantities of the long-term and short-term bonds, per se, that determine the effects on the term structure of interest rates. What determines these effects is how public debt management affects the hedging opportunities through changes in asset supply, taxes and prices. / Diss. Stockholm : Handelshögskolan

Interactions between macroeconomic fundamentals and term structure of interest rates be stronger according to the way of changes in structure of worldwide economy. Combined macro-finance analysis determines the joint dynamics of term structure of interest rates and macroeconomic fundamentals. This thesis provides analysis of two existing macro-finance models and an original one. Parameter estimations for these three macro-finance term structure models are done for monthly Turkish data by use of an efficient recursive estimator Kalman filter. In spite of the small scale application the results are satisfactory except first model but with longer sets of macroeconomic variables and interest rate data models provide more encouraging results.

The essence of the interest rate modeling by using Heath-Jarrow-Morton framework is to find the drift condition of the instantaneous forward rate dynamics so that the entire term structure is arbitrage free. In this study, instantaneous forward interest rates are modeled using random fields and Markov Jump processes and the drift conditions of the forward rate dynamics are given. Moreover, the methodology presented in this study is extended to certain financial settings and instruments such as multi-country interest rate models, term structure of defaultable bond prices and forward measures. Also a general framework for bond prices via nuclear space valued semi-martingales is introduced.

In my dissertation, I explore the relationship between capital controls and the choice of the maturity structure of external debt in a general equilibrium setup, incorporating explicitly the role of international lenders. I look at specific types of capital controls which take the form of date-specific and maturity-specific reserve requirements on external borrowing. I consider two questions: How is the maturity structure of external debt determined in a world general equilibrium? What are the effects of date- and maturity-specific reserve requirements on the maturity structure of external debt? Can they prevent a bank run? I develop a simple Diamond-Dybvig-type model with three dates. In the low income countries, banks arise endogenously. There are two short-term bonds and one long-term bond offered by the domestic banks to international lenders. First I look at a simple model were international lending is modeled exogenously. I consider explicitly the maturity composition of capital inflows to a domestic economy. I show that the holdings of both short-term bonds are not differentiated according to date. Second, I consider international lending behavior explicitly. The world consists of two large open economies: one with high income and one with low income. The high income countries lend to low income countries. There exist multiple equilibria and some are characterized by relative price indeterminacy. Third, I discuss date-specific and maturity- specific reserve requirements. In my setup reserve requirements play the role of a tax and the role of providing liquidity for each bond at different dates. I show that they reduce the scope of indeterminacy. In some equilibria, I identify a case in which the reserve requirement rate on the long-term debt must be higher than that on the short-term debt for a tilt towards a longer maturity structure. Fourth, I introduce the possibility of an unexpected bank run. I show that some specific combination of date-and maturity-specific reserve requirements reduce the vulnerability to bank runs. With regard to the post-bank-run role of international lenders, I show that international lenders may still want to provide new short-term lending to the bank after the occurrence of a bank run.

<p>My dissertation, consisting of three related essays, aims to understand the role of macroeconomic risks in the stock and bond markets. In the first chapter, I build a financial intermediary sector with a leverage constraint a la Gertler and Kiyotaki (2010) into an endowment economy with an independently and identically distributed consumption growth process and recursive preferences. I use a global method to solve the model, and show that accounting for occasionally binding constraint is important for quantifying the asset pricing implications. Quantitatively, the model generates a procyclical and persistent variation of price-dividend ratio, and a high and countercyclical equity premium. As a distinct prediction from the model, in the credit crunch, high TED spread, due to a liquidity premium, coincides with low stock price and high stock market volatility, a pattern I confirm in the data.</p><p>In the second chapter, which is coauthored with Hengjie Ai and Mariano Croce, we model investment options as intangible capital in a production economy in which younger vintages of assets in place have lower exposure to aggregate productivity risk. In equilibrium, physical capital requires a substantially higher expected return than intangible capital. Quantitatively, our model rationalizes a significant share of the observed difference in the average return of book-to-market-sorted portfolios (value premium). Our economy also produces (1) a high premium of the aggregate stock market over the risk-free interest rate, (2) a low and smooth risk-free interest rate, and (3) key features of the consumption and investment dynamics in the U.S. data.</p><p>In the third chapter, I study the joint determinants of stock and bond returns in Bansal and Yaron (2004) long-run risks model framework with regime shifts in consumption and inflation dynamics -- in particular, the means, volatilities, and the correlation structure between consumption growth and inflation are regime-dependent. This general equilibrium framework can (1) generate time-varying and switching signs of stock and bond correlations, as well as switching signs of bond risk premium; (2) quantitatively reproduce various other salient empirical features in stock and bond markets, including time-varying equity and bond return premia, regime shifts in real and nominal yield curve, the violation of expectations hypothesis of bond returns. The model shows that term structure of interest rates and stock-bond correlation are intimately related to business cycles, while long-run risks play a more important role to account for high equity premium than business cycle risks.</p> / Dissertation