CHAPTERTHIRTY-SEVENA FRAMEWORK FOR ANALYZING YIELD-CURVE TRADES
ANTTI ILMANEN, PH.D.
Managing DirectorAQR Capital Management (Europe) LLP
In Chapter 36, it was explained that the shape of the yield-curve depends on three main determinants: the market’s rate expectations, the required bond risk premia, and the convexity bias. In this chapter we show how to decompose the forward rate curve into these three determinants. Even though we cannot observe these determinants directly, the decomposition can clarify our thinking about the yield-curve.
Our analysis also produces direct applications—it provides a systematic framework for relative-value analysis of noncallable government bonds. Analogous to the decomposition of forward rates, the total expected ...