1. Lecture 5 Historical Interest Rate Movements

2. Term Structure Shapes Normal upward sloping Inverted Level Humped

3. How Do Curves Shift? Litterman and Scheinkmann (1991) investigated the factors that affect yield movements Over 95% of yield changes are explained by a combination of three different factors –Level –Steepness –Curvature

4. Level Shifts Rates of maturities shift by approximately the same amount Also called a parallel shift

5. Steepness Shifts Short rates move more (or less) than longer term interest rates Changes the slope of the yield curve

6. Curvature Shifts Shape of curve is altered Short and long rates move in one direction, intermediate rates move in the other

7. Characteristics of Historical Interest Rate Movements Rule out negative interest rates Higher volatility in short-term rates, lower volatility in long-term rates Mean reversion (weak) Correlation between rates closer together is higher than between rates far apart Volatility of rates is related to level of the rate

8. Summary Statistics for Historical Rates (1953-2001) http://www.federalreserve.gov/releases/H15/data.htm

9. Run Graph Show of Interest Rates Go to: http://www.cba.uiuc.edu/~s-darcy/present/casdfa3/intmodels.html Download Graph Show Click on Historical (4/53-5/99) Click on Start Graph Show You may want to shorten the time interval to speed up the process Note how interest rates have moved over the last 46 years Pay attention to the level of interest rates, the shape of the yield curve and the volatility over time

10. Current Interest Rates Yields Spot rates Implied forward rates

12. Distortions U. S. Government stopped issuing 30 year bonds in October, 2001 Reduced supply of long term bonds has increased their price, and reduced their yields Effect has distorted the yield curve

13. Conclusion Interest rates fluctuate Interest rate models are used to predict future interest rate movements Historical information useful to determine type of fluctuations that occur –Shapes of term structure –Volatility –Mean reversion –Long run mean levels Don’t assume best model is the one that fits past movements the best