Yield Curve Risk Factors: Domestic and Global Contexts

Wesley Phoa, Ph.D.

Non-parallel yield curve movements are an important source of risk for both benchmarked total return investors and asset/liability managers. This expository article (a) describes principal component analysis, an empirical analysis of yield curve dynamics that provides a basis for efficient measurement and hedging non-parallel risk; (b) illustrates its advantages and its potential pitfalls using several decades of data from both US and international markets; (c) discusses the role it can play in practical risk management; and (d) sketches a macroeconomic interpretation of yield curve dynamics consistent with the results of principal components analysis.