The recent financial crises observed in the United States, the United Kingdom and the euro area have led their respective central banks to bring policy rates down to unprecedented low levels, with an associated dramatic drop of their yield curves. Short term rates have remained at their lower bound for extended periods of time while longer term rates have fluctuated with relatively high volatilities. This paper describes a new class of non-negative affine term structure models introduced by Monfort et al. (2017) and used to replicate these features of the yield curve. The proposed empirical analysis also suggests that ignoring interest rate risk premia implies a substantial underestimation of the length of the zero lower bound regime.
Before the burst of the 2008 financial crisis, the Bank of Japan was the only large central bank that had brought its policy rate down close to zero. Since 2010 however, keeping policy rates close to the zero lower bound (ZLB) has become a common practice for the American Federal Reserve System (Fed), the European Central Bank (ECB) and the Bank of England (BoE). In June 2014, the ECB became the first major central bank to lower one of its key policy rates (the deposit facility rate) into negative territory. In all of these currency areas, sharp decreases in short‑term rates have pushed the yield curves down to unprecedented low levels.
For instance, between January 1995 and December 2007, the average level of the German sovereign yield curve was between 3% and 5% for 80% of the time (see Chart 1); over the same period, the 3‑month rate of the Bund was between 2% and 4% for 80% of the time. Between January 2008 and February 2017, the average German yield curve level was below 1% for 60% of the time, and below 2.5% (see Chart 1) for 90% of the time. The 3‑month Bund rate stayed around zero (between –50bps and +50bps) for 75% of the time.
Updated on: 12/14/2017 17:43