Parsimonious Modeling of Yield Curves

Abstract

This paper introduces a parametrically parsimonious model for yield curves that has the ability to represent the shapes generally associated with yield curves: monotonic, humped, and S shaped. We find that the model explains 96% of the variation in bill yields across maturities during the period 1981-83. The movement of the parameters through time reflects and confirms a change in Federal Reserve monetary policy in late 1982. The ability of the fitted curves to predict the price of the long-term Treasury bond with a correlation of .96 suggests that the model captures important attributes of the yield/maturity relation.