Yield curve in India and its interactions with the US bond market
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This paper examines the dynamics of the yield curve in India. The study decomposes the entire yield curve into three latent factors (viz. level, slope and curvature) for both the Indian and US sovereign bond markets using the dynamic Nelson Siegel model applying Kalman filter in state space framework. The extracted level factor represents long term, the slope represents short term and the curvature represents medium term interest rate factor. Using the extracted latent factors, the impact of the US yield curve interactions upon the Indian yield curve has been investigated. It provides a new dimension to the literature through investigating the influence of external factors (i.e. US contribution) on the emerging economy yield curve. It is found that the level and slope of the US market leads the long end of the Indian yield curve. The Indian slope was domestic in nature, but after the global financial crisis, linkages between the Indian slope and the US yield curve have increased. The results of this study would enable policy makers to understand the interactions between the domestic yield curve and US market and ensure monetary policy stabilisation. The linkages will also help the global investors in their asset allocation decisions.
KeywordsYield curve Dynamic Nelson Siegel model Global financial crisis
JEL ClassificationE430 G12 G15 G010 G2 C58
The first draft of this paper has been presented in “India Finance Conference −2014” organized in association with IIM- Ahmedabad, IIM- Calcutta and IIM – Bangalore held at IIM- Bangalore during December 17–18, 2014.
Authors also acknowledge the financial support provided by Indian Council of Social Science Research (ICSSR) for the research work.
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