Riding the Yield Curve: Risk Taking Behavior in a Low Interest Rate Environment

By Ralph Chami, Thomas F. Cosimano, Celine Rochon, Julieta Yung

March 13, 2020

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Ralph Chami, Thomas F. Cosimano, Celine Rochon, and Julieta Yung. Riding the Yield Curve: Risk Taking Behavior in a Low Interest Rate Environment, (USA: International Monetary Fund, 2020) accessed December 3, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

Investors seek to hedge against interest rate risk by taking long or short positions on bonds of different maturities. We study changes in risk taking behavior in a low interest rate environment by estimating a market stochastic discount factor that is non-linear and therefore consistent with the empirical properties of cashflow valuations identified in the literature. We provide evidence that non-linearities arise from hedging strategies of investors exposed to interest rate risk. Capital losses are amplified when interest rates increase and risk averse investors have taken positions on instruments with longer maturity, expecting instead interest rates to revert back to their historical average.

Subject: Bonds, Financial institutions, Financial markets, Financial regulation and supervision, Financial services, Market risk, Securities, Securities markets, Yield curve

Keywords: Averse investor, Bonds, Expected SDF, Global, Hedging strategy, Interest rate movement, Interest rate risk, Interest-rate risk factors, Investment portfolio, Investors aversion, Low interest rate environment, Market risk, Non-linear stochastic discount factor, Risk aversion distribution, Securities, Securities markets, Term structure model, WP, Yield curve

Publication Details

Pages:

26
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2020/053
Stock No:

WPIEA2020053
ISBN:

9781513531861
ISSN:

1018-5941

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