Title: A VAR-based factor decomposition to the term structure of treasury bonds

Authors: Mengxue Zhao; Dejun Xie; David A. Edwards; Yujian Liu

Addresses: School of Mathematical Sciences, Xi'an Jiaotong-Liverpool University, Suzhou City, 215123, China ' School of Mathematical Sciences, Xi'an Jiaotong-Liverpool University, Suzhou City, 215123, China ' Department of Mathematical Sciences, University of Delaware, Newark, De, 19716, USA ' School of Mathematical Sciences, Xi'an Jiaotong-Liverpool University, Suzhou City, 215123, China

Abstract: This paper analyses the dimensions of the term structure and explains their associations with macroeconomic parameters that foretell financial crises. Five prominent financial economic indicators were found, collectively explaining the dynamics of bond yields. Data from China's bond market from 2007 to 2019 were used to calibrate our model and hypothesis. The VAR model was adopted to explore in what direction and to what extent the early warning indicators of financial crises may effect changes in the term structure. Given its high complexity and the irregularity of its occurrence in different economies, it is usually a challenging task to quantitatively model financial crises. This challenge has been handled by an indirect approach introduced in the current study, linking the original limited sample size problem to a VAR-based model with abundant time series data. The findings provide an implementable scheme that may be used to design an early warning system of financial crises.

Keywords: term structure of interest rates; financial crisis; bond yield curve; VAR model; variance decomposition.

DOI: 10.1504/IJMEF.2022.128506

International Journal of Monetary Economics and Finance, 2022 Vol.15 No.6, pp.585 - 613

Received: 11 Jan 2021
Accepted: 06 Jan 2022
Published online: 24 Jan 2023 *

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