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Today’s forecast for U.S. Treasury yields is based on the November 23, 2011 constant maturity Treasury yields that were reported by the Board of Governors of the Federal Reserve System in its H15 Statistical Release at 4:15 pm November 25, 2011 because interest rate data was not available for November 24 due to the holiday. The “forecast” is the implied future coupon bearing U.S. Treasury yields derived using the maximum smoothness forward rate smoothing approach developed by Adams and van Deventer (Journal of Fixed Income, 1994) and corrected in van Deventer and Imai, Financial Risk Analytics (1996). For an electronic delivery of this interest rate data in Kamakura Risk Manager table format, please subscribe via info@kamakuraco.com.

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In our blog of November 7, 2011, we showed that the one–factor term structure models in wide use in the financial services business for interest rate management analytics were consistent with actual daily movements of the U.S. Treasury curve less than 38% of 12,286 business days since 1962.  In this blog, we repeat the analysis on the Libor-swap curve and reach an even more devastating conclusion: once the full interest rate swap curve came into view in 1988, daily yield curve shifts were consistent with one factor models less than 8% of the time.  This blog explains how we arrived at those conclusions.

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Today’s forecast for U.S. Treasury yields is based on the November 17, 2011 constant maturity Treasury yields that were reported by the Board of Governors of the Federal Reserve System in its H15 Statistical Release at 4:15 pm November 18, 2011. The “forecast” is the implied future coupon bearing U.S. Treasury yields derived using the maximum smoothness forward rate smoothing approach developed by Adams and van Deventer (Journal of Fixed Income, 1994) and corrected in van Deventer and Imai, Financial Risk Analytics (1996). For an electronic delivery of this interest rate data in Kamakura Risk Manager table format, please subscribe via info@kamakuraco.com.

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Today’s forecast for U.S. Treasury yields is based on the November 9, 2011 constant maturity Treasury yields that were reported by the Board of Governors of the Federal Reserve System in its H15 Statistical Release at 4:15 pm November 10, 2011 because interest rate data was not available for November 10 due to the holiday. The “forecast” is the implied future coupon bearing U.S. Treasury yields derived using the maximum smoothness forward rate smoothing approach developed by Adams and van Deventer (Journal of Fixed Income, 1994) and corrected in van Deventer and Imai, Financial Risk Analytics (1996). For an electronic delivery of this interest rate data in Kamakura Risk Manager table format, please subscribe via info@kamakuraco.com.

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One factor models of the term structure of interest rates were developed to provide insights into the valuation of fixed income options.  Since the models’ early development from 1977 to 1993, they have been consistently misapplied in asset and liability (interest rate risk) management.  Many analysts, choosing one of the common one factor models, create random interest rate scenarios to evaluate the interest rate risk of the firm.  This blog post uses 50 years of U.S. Treasury yield curve information to prove that the major implications of one factor term structure models are inconsistent with historical data.  A multi-factor approach is necessary to create realistic interest rate simulations. The author wishes to thank Professor Robert A. Jarrow for helpful comments. Any errors that remain are those of the author alone.
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