Chapter 46. Analyzing and Interpreting the Yield Curve

MOORAD CHOUDHRY, PhD

Head of Treasury, KBC Financial Products, London

Abstract: Considerable effort is expended by bond analysts and economists in analyzing and interpreting the shape of the yield curve. This is because the market perceives that there is significant information content associated with any yield curve at any time. In general, the benchmark yield curve serves as a snapshot of market expectations, both with regard to the future level of interest rates as well as other economic indicators such as inflation rates. By considering the shape and level of the yield curve today, we can draw conclusions on what the market believes will be the case in the future. This belief is an implied one, in that the shape of the curve today implies what interest rates and inflation should be in the future. At any one time, the yield curve reflects market expectations based on all known information up to that point. As new information is received and analyzed, the shape and level of the yield curve changes to reflect this latest information. As such, a yield curve is a static snapshot of a dynamic situation.

Keywords: yield curve, expectations hypothesis, local expectations hypothesis, unbiased expectations hypothesis, return-to-maturity expectations hypothesis, yield-to-maturity hypothesis, risk-neutral expectations hypothesis, liquidity preference theory, money substitute theory, segmented markets theory, preferred habitat theory

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