José Valentim Machado Vicente

Does Curvature Enhance Forecasting

In this paper, we analyze the importance of curvature term structure movements on forecasts of interest rates. An extension of the exponential three-factor Diebold and Li (2006) model is proposed, where a fourth factor captures a second type of curvature. The new factor increases model ability to generate volatility and to capture nonlinearities in the yield curve, leading to a significant improvement of forecasting ability. The model is tested against the original Diebold and Li model and some other benchmarks. Based on a forecasting experiment with Brazilian fixed income data, it obtains significantly lower bias and root mean square errors for most examined maturities, and under three different forecasting horizons. Robustness tests based on two sub-sample analyses partially confirm the favorable results.

Forecasting Bond Yields with Segmented Term Structure Models

Recent empirical analysis of interest rate markets documents that bond demand and supply directly affect yield curve movements and bond risk premium. Motivated by those findings we propose a parametric interest rate model that allows for segmentation and local shocks in the term structure. We split the yield curve in segments presenting their own local movements that are globally interconnected by smoothing conditions. Two classes of segmented exponential models are derived and compared to successful term structure models based on a sequence of out-of-sample forecasting exercises. Adopting U.S. interest rates data available from 1985 to 2008, the segmented models present overall better forecasting performance suggesting that local shocks might indeed be important determinants of yield curve dynamics.

Do inflation-linked bonds contain information about future inflation?

There is a widespread belief that inflation-linked bonds are a direct source of information about inflation expectations. In this paper we address this issue by analyzing the relationship between break-even inflation (the difference between nominal and real yields) and future inflation. The dataset is extracted from Brazilian Treasury bonds covering the period from April 2005 to April 2011. We find that break-even inflation is an unbiased forecast only of the 3-month and 6-month ahead inflation. For medium horizons (12 and 18 months), break-even inflation has weak explanatory power of future inflation. Over long horizons (24 and 30 months), we report a significant, but counterintuitive, negative relationship between the break-even and realized inflation rates.

Term structure movements implicit in Asian option prices

In this paper we implement dynamic term structure models that adopt bonds and Asian options in the estimation process. The goal is to analyse the pricing and hedging implications of term structure movements when options are (or are not) included in the estimation process. We investigate how options affect the shape, risk premium and hedging structure of the dynamic factors. We find that the inclusion of options affects the loadings of the slope and curvature factors, and considerably changes the risk premium and hedging structure of all dynamic factors.

Nonparametric Tail Risk, Stock Returns and the Macroeconomy

This paper introduces a new tail risk measure based on the risk-neutral excess expected shortfall of a cross-section of stock returns. We propose a novel way to risk neutralize the returns without relying on option price information. Empirically, we illustrate our methodology by estimating a tail risk measure over a long historical period based on a set of size and book-to-market portfolios. We find that a risk premium is associated with long-short strategies with portfolio sorts based on tail risk sensitivities of individual securities. Our tail risk index also provides meaningful information about future market returns and aggregate macroeconomic conditions. Results are robust to the cross-sectional information selected to compute the tail risk measure.

Movimentos da Estrutura a Termo e Critérios de Minimização do Erro de Previsão em um Modelo Paramétrico Exponencial

In this paper, we study how different choices of loadings affect forecasting in the exponential term structure model proposed by Diebold and Li (2006). The loadings are defined through a specific parameter lambda which controls both the decaying speed of the slope as well as the maximum of the curvature factors. In particular, adopting a database including Brazilian fixed income future contracts (ID future), we analyze four different rules of choices depending on metrics that minimize forecasting errors, for different forecasting horizons. We conclude that the optimal rule changes for different regions of ID future maturities/different forecasting horizons, indicating that the choice of how movements will be parameterized in this exponential model should be done with care, tailored for each particular application of the model.

Decompondo a Inflação Implícita

The break-even inflation rate (the difference between nominal and real rates) is the main indicator of future price level. However, inflation expectation is only one of its components. In this article we present a simple economic model in order to split the break-even inflation rate in the following fundamental factors: inflation expectation, convexity term, and liquidity and inflation risk premia. Using Brazilian data from January 2006 to September 2013 we evaluate each one of these terms. Inflation expectations are read directly from Focus, a survey conducted by Central Bank of Brazil. In our setup, the convexity term or Jensens correction is equal to the variance of inflation rate. We report a very small convexity term which is in line with the literature on the subject. Its magnitude is around one basis point, less than the bid-ask spread of Brazilian fixed income bonds. Although there is a significant difference between the trading volume of real and nominal bonds, we find that this liquidity difference is not priced (liquidity premium is not significant). This result is apparently contradictory. However, it is due to the fact that, in Brazil, real bonds are usually held to maturity. Therefore investors do not demand a reward to exposure to liquidity uncertainty which in turn eliminates the relevance of this premium. Finally, we show that the inflation risk premium is nearly zero for short horizons. For long horizons this risk premium is time varying and close related with consumption and stock market volatility, consistent with economic theory

Extracting inflation risk premium from nominal and real bonds using survey information

Purpose The purpose of this paper is to forecast future inflation using a joint model of the nominal and real yield curves estimated with survey data. The model is arbitrage free and embodies incompleteness between the nominal and real bond markets. Design/methodology/approach The methodology is based on the affine class of term structure of interest rate. The model is estimated using the Kalman filter technique. Findings The authors show that the inclusion of survey data in the estimation procedure improves significantly the inflation forecasting. Moreover, the authors find that the monetary policy has significant effects on the inflation expectation and risk premium. Originality/value This paper is the first to estimate inflation using a joint model of nominal and real yield curves with Brazilian data. Moreover, the authors propose a simple arbitrage-free model that takes it account incompleteness between the nominal and real bond markets.

Do central bank foreign exchange interventions affect market expectations

ABSTRACT The aim of this article is to study the impact of the Brazilian central bank swap interventions on the FX market from 2006 to 2013. In this period, these nontraditional interventions were the main FX instrument of the Brazilian Government. Since the central bank operates through a sequence of daily interventions in most of the period, we employ the event study method, which is appropriate to investigate cumulative impact of intervention episodes. We analyse the effects on the risk neutral distribution of BRL-USD exchange rate, which incorporates economic valuation besides the likelihoods. We investigate both changes in level and in the dynamics of the moments. Our tests indicate that interventions have little effects on the exchange rate distribution. We only find evidences of some impact on the dynamics of the mean, volatility and skewness over long horizons when the central bank takes short positions on the exchange rate.