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Common factors in international bond returns

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  • Driessen, Joost
  • Melenberg, Bertrand
  • Nijman, Theo

Abstract

In this paper we estimate and interpret the factors that jointly determine bond returns of different maturities in the US, Germany and Japan.We analyze both currency-hedged and unhedged bond returns.For currency-hedged bond returns, we find that five factors explain 96.5% of the variation of bond returns.These factors can be associated with changes in the level and steepness of the term structures in (some of) these countries.In particular, it turns out that changes in the level of the term structures are correlated across countries, while changes in the steepness of the term structures are country-specific.The five-factor model also provides a good fit of the expected returns of bond returns in all countries.We find similar results for bond returns that are not hedged for currency risk.Finally, we show how the model can be used to calculate the Value at Risk for international bond portfolios and to price cross-currency interest rate derivatives, and compare the results with simpler models.
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Suggested Citation

  • Driessen, Joost & Melenberg, Bertrand & Nijman, Theo, 2003. "Common factors in international bond returns," Journal of International Money and Finance, Elsevier, vol. 22(5), pages 629-656, October.
    • Handle: RePEc:eee:jimfin:v:22:y:2003:i:5:p:629-656
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    References listed on IDEAS

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    1. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
    2. Stephen A. Ross, 2013. "The Arbitrage Theory of Capital Asset Pricing," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 1, pages 11-30, World Scientific Publishing Co. Pte. Ltd..
    3. Antoine Frachot, 1995. "Factor Models Of Domestic And Foreign Interest Rates With Stochastic Volatilities," Mathematical Finance, Wiley Blackwell, vol. 5(2), pages 167-185, April.
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    5. Ilmanen, Antti, 1995. "Time-Varying Expected Returns in International Bond Markets," Journal of Finance, American Finance Association, vol. 50(2), pages 481-506, June.
    6. Frederick R. Macaulay, 1938. "Some Theoretical Problems Suggested by the Movements of Interest Rates, Bond Yields and Stock Prices in the United States since 1856," NBER Books, National Bureau of Economic Research, Inc, number maca38-1.
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    More about this item

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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