We address two empirical issues related to the long end of the yield curve based on euro swap rates. First, for maturities longer than 20 years we find evidence for an `excess' downward slope that cannot be explained by convexity. Second, volatility at the very long end of the yield curve is larger than predicted by no-arbitrage models. We construct a model-based arbitrage-free extrapolation of the yield-curve and compare it to the regulatory discount curve. Because of near-zero mean reversion, there is no convergence towards an `ultimate forward rate' and convexity effects cause the arbitrage-free extrapolations to have slightly downward sloping curves. The low level of mean-reversion also implies that the volatility of long-term rates does not decline relative to the 20-year volatility. Therefore, we conclude that the mean-reversion and resulting smoothing adopted by the regulatory curve is much too strong.
|Number of pages||36|
|Publication status||Published - 19 Nov 2020|
- g23 - "Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors"
- g12 - "Asset Pricing; Trading volume; Bond Interest Rates"
- c58 - Financial Econometrics
- term structure models
- Parameter uncertainty
- insurance supervision