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Term premium dynamics and its determinants: the Mexican case

Author

Listed:
  • Ana Aguilar
  • María Diego-Fernández
  • Rocio Elizondo
  • Jessica Roldán-Peña

Abstract

We estimate the term premium implicit in 10-year Mexican government bonds from 2004 to 2019, and analyze the main determinants explaining its dynamics. To do so, we decompose the long-term interest rate into its two components: the expected shortterm interest rate and the term premium. The first component is obtained using different methodologies, two affine models and data on interest rate swaps. The second component is computed as the difference between long-term interest rates and such short-term rate. The Mexican term premium is represented by the average of the three estimations. We find that the Mexican term premium increased considerably during three episodes compared to the entire dynamics of said premium: i) the Global Financial Crisis of 2008; ii) the Taper Tantrum of 2013; and iii) the U.S. presidential election of 2016. In contrast, we find that the Mexican term premium decreased, to historically low levels, during the U.S. Quantitative Easing and Operation Twist programs. Additionally, in order to identify the main determinants that explain the behavior of this premium, we run a time varying parameters regression. In this analysis, we find that the main determinants that explain the dynamics of the premium are the compensation for FX risk (as a proxy of inflationary risk premium), the real compensation, and the U.S. term premium (as a global factor).

Suggested Citation

  • Ana Aguilar & María Diego-Fernández & Rocio Elizondo & Jessica Roldán-Peña, 2022. "Term premium dynamics and its determinants: the Mexican case," BIS Working Papers 993, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:993
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    1. Erasmus, Ruan & Steenkamp, Daan, 2022. "South Africa’s yield curve conundrum," MPRA Paper 115398, University Library of Munich, Germany.

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    More about this item

    Keywords

    term premium; short-term interest rate expectation; affine model.;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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