A no-arbitrage structural vector autoregressive model of the UK yield curve

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 05 December 2008

Working Paper No. 357
By Iryna Kaminska

This paper combines a structural vector autoregression (SVAR) with a no-arbitrage approach to build a multifactor affine term structure model (ATSM). The resulting no-arbitrage structural vector autoregressive (NA-SVAR) model implies that expected excess returns are driven by the structural macroeconomic shocks. This is in contrast to a standard ATSM, in which agents are concerned with non-structural risks. As a simple application of a NA-SVAR model, we study the effects of supply, demand and monetary policy shocks on the UK yield curve. We show that all shocks affect the slope of the yield curve, with demand and supply shocks accounting for a large part of the time variation in bond yields. The short end of the yield curve is driven mainly by the expectations component, while the term premium matters for the dynamics of the long end of the yield curve.

PDFA no-arbitrage structural vector autoregressive model of the UK yield curve

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