Essays on the term structure of interest rates

Abstract

In this thesis, we investigate two issues related with the comovement of international term structure. Understanding the dynamics of the term structure of interest rates is important for various financial market activities such as asset allocation, derivatives pricing, hedging, and risk management. In chapter 2, we investigate the strength of comovements of cross-country interest rates and identify the factors driving such comovements in international term structures. Recently, the financial markets become more volatile on the back of financial crisis triggered by the subprime crisis. Therefore, we investigate how an asymmetric correlation is reflected in term structure shapes and what are primary drivers behind such asymmetric correlations during the subprime crisis. We find that after the subprime crisis, an additional common factor is found which can be interpreted as the “slope” factor of the joint term structure. This result shows that there is an important structural change in the dynamics of international term structure. In chapter 3, we extend the canonical model for single country affine term structure models (ATSMs) provided by Dai and Singleton (2000) into a two-country setup and investigate the performance of our joint affine term structure models (JATSMs) in capturing the correlations of term structure slopes of two countries. To the best of our knowledge, this paper is the first to directly investigate the adequacy of various JATSMs in capturing the correlation dynamics of international term structure slopes. We employ the efficient method of moments (EMM) developed by Gallant and Tauchen (1996) to estimate the parameters of our JATSMs. In particular, we complement the EMM specification test by employing the reprojection analysis of Gallant and Tauchen (1998). We find that $JA_2 (3)$ shows best performance in explaining the correlation dynamics between the US and UK term structure slopes. Our reprojection analysis reveals that $JA_2 (3)$ is ...