Term Premium Dynamics and its Determinants: The Mexican Case
DOI:
https://doi.org/10.47872/0yfwma90Keywords:
Term premium, short-term interest rate expectation, affine modelAbstract
We estimate the term premium implicit in 10-year Mexican government bonds from
2004 to 2019, and analyze the main determinants explaining its dynamics. We decompose
the long-term interest rate into its two components: the expected short-term
interest rate and the term premium. The first is obtained using two affine models and
data on interest rate swaps. The second is computed as the difference between longterm
rates and such expectation. The results show that the term premium increased
significantly during three episodes: the global financial crisis; the “Taper Tantrum”;
and the U.S. presidential election of 2016. In contrast, the term premium decreased,
to historically low levels, during the U.S. “Quantitative Easing” and the “Operation
Twist” programs. Additionally, the main determinants that explain the dynamics of
the premium are the compensation for FX risk (as a proxy of inflationary risk premium),
the real compensation, and the U.S. term premium (as a global factor).
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