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Understanding the Real Rate Conundrum: An Application of No-Arbitrage Models to the UK Real Yield Curve

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  • Michael A. S. Joyce
  • Iryna Kaminska
  • Peter Lildholdt

Abstract

During 2004 and 2005, long-horizon interest rates fell sharply in major international government bond markets (Greenspan's "conundrum"). This common fall mainly reflected lower long real rates. To investigate possible causes, the authors apply a no-arbitrage affine modeling framework to understanding the UK real term structure. The authors find that time-varying term premia are important in explaining movements in long real forward rates. And, although there is evidence that long-horizon expected short real rates declined over the conundrum period, the authors' results suggest that lower term premia played the dominant role. This could be consistent with the so-called "search for yield" and excess liquidity explanations for the conundrum. Copyright 2011, Oxford University Press.

Suggested Citation

  • Michael A. S. Joyce & Iryna Kaminska & Peter Lildholdt, 2011. "Understanding the Real Rate Conundrum: An Application of No-Arbitrage Models to the UK Real Yield Curve," Review of Finance, European Finance Association, vol. 16(3), pages 837-866.
    • Handle: RePEc:oup:revfin:v:16:y:2011:i:3:p:837-866
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    Cited by:

    1. Iryna Kaminska & Gabriele Zinna, 2020. "Official Demand for U.S. Debt: Implications for U.S. Real Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(2-3), pages 323-364, March.
    2. Iryna Kaminska & Dimitri Vayanos & Gabriele Zinna, 2011. "Preferred-Habitat Investors and the US Term Structure of Real Rates," FMG Discussion Papers dp674, Financial Markets Group.
    3. Jonathan Hambur & Richard Finlay, 2018. "Affine Endeavour: Estimating a Joint Model of the Nominal and Real Term Structures of Interest Rates in Australia," RBA Research Discussion Papers rdp2018-02, Reserve Bank of Australia.
    4. Jens H. E. Christensen & Glenn D. Rudebusch, 2019. "A New Normal for Interest Rates? Evidence from Inflation-Indexed Debt," The Review of Economics and Statistics, MIT Press, vol. 101(5), pages 933-949, December.
    5. Gabriele Zinna, 2014. "Price pressures in the UK index-linked market: an empirical investigation," Temi di discussione (Economic working papers) 968, Bank of Italy, Economic Research and International Relations Area.
    6. Bruno Feunou & Jean-Sébastien Fontaine, 2021. "Debt-Secular Economic Changes and Bond Yields," Staff Working Papers 21-14, Bank of Canada.

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