Extraction of proxy relative sovereign bond yield curve factors

ABSTRACT

This study analyses the relationship between sovereign yield factors and exchange rate changes. A new method is proposed to extract proxy relative yield factors from the yield curves of two countries. As previous studies showed (e.g. Chen and Tsang 2013; Wellmann and Trück 2018), the relative yield curve factors play an important role in explaining the variation in the foreign exchange rates. Especially, the proxy relative level and slope factors have explanatory power for exchange rate changes, especially for the JPY/USD pair.

KEYWORDS:

• Exchange rate
• yield curve
• relative yield factors
• sovereign bonds

JEL CLASSIFICATION:

• E43
• G10
• G15

Disclosure statement

No potential conflict of interest was reported by the author(s).

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

¹ Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets in 2019.

² The sovereign bonds data of Canada were obtained from the database of Bank of Canada. This study complements the lack of data for U.K. sovereign bonds in Refinitive EIKON with data from the Bank of England.

³ The sample period for the Swiss data is April 1995 to October 2020. The 3-, 6- and 12-month yields are the deposit rates in Australia and Switzerland.

⁴ They employ the proxy definition as a yield latent factor in the one-country model.

⁵ This study follows Diebold, Rudebusch, and Aruoba (2006) method.

Additional information

Funding

This work was supported by Japan Society for the Promotion of Science (JSPS) KAKENHI (Grant Number 20K22109).