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The effect of interest rate volatility on treasury yields

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  • Sudipto Sarkar
  • Mohamed Ariff

Abstract

There is a substantial literature on the level and volatility of interest rates. However, there is no agreement to date on the relationship between the two, e.g., whether higher interest rate volatility will result in higher or lower bond yields. Further, there is virtually no research on the role of maturity in this relationship. It is hypothesized that, because of the stochastic nature of interest rates and the embedded option associated with the government's ability to time its borrowings, there should be a negative relationship between interest rate volatility and Treasury yields. Moreover, this negative relationship should be stronger for longer-maturity bonds, everything else held constant. This hypothesis is tested empirically, using bond yield data from the US Treasury market. The main finding is that interest rate volatility does indeed have a significant negative effect on bond yields, and the significance is greater for 20-year bonds than for 10-year bonds, as hypothesized. This result adds a wrinkle to the already complicated policy issue of what range of interest rate volatility is desirable from a 'social optimum' standpoint.

Suggested Citation

  • Sudipto Sarkar & Mohamed Ariff, 2002. "The effect of interest rate volatility on treasury yields," Applied Financial Economics, Taylor & Francis Journals, vol. 12(9), pages 667-672.
    • Handle: RePEc:taf:apfiec:v:12:y:2002:i:9:p:667-672
    DOI: 10.1080/09603100010018759
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    References listed on IDEAS

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    1. Leahy, J.V., 1991. "The Optimality of Myopic Behaviour in a Competitive Model of Entry and Exit," Harvard Institute of Economic Research Working Papers 1566, Harvard - Institute of Economic Research.
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    Cited by:

    1. Covarrubias, Guillermo & Ewing, Bradley T. & Hein, Scott E. & Thompson, Mark A., 2006. "Modeling volatility changes in the 10-year Treasury," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 369(2), pages 737-744.
    2. Billio, Monica & Dufour, Alfonso & Segato, Samuele & Varotto, Simone, 2023. "Complexity and the default risk of mortgage-backed securities," Journal of Banking & Finance, Elsevier, vol. 155(C).
    3. Asif Mahmood, 2016. "Transmission of Volatility of Money Market Overnight Repo Rate along the Yield Curve in Pakistan," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 12, pages 1-18.
    4. Emel Siklar & Ilyas Siklar, 2021. "Time Series Dynamics of Short Term Interest Rates in Turkey," Business and Economic Research, Macrothink Institute, vol. 11(1), pages 92-108, March.
    5. Alexius, Annika, 2004. "Far Out on the Yield Curve," Working Paper Series 2004:12, Uppsala University, Department of Economics.
    6. Emenike Kalu O., 2017. "The Interrelationship between Crude Oil Price Volatility and Money Market Rate Volatility in a Developing, Oil-Producing Economy," Eastern European Business and Economics Journal, Eastern European Business and Economics Studies Centre, vol. 3(1), pages 28-47.

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