Measuring Yield Curve Movements: A Principal Component Analysis of Spot Rate Changes in the JPY, USD, GBP, and CHF Interest Rate Swap Markets

Abstract

This chapter explores the yield curve movements in the interest rate swap markets of four major currencies, the Japanese yen (JPY), the US dollar (USD), the pound sterling (GBP), and the Swiss franc (CHF), by principal component analysis (PCA), focusing on the explanatory power of each driver. Comparing the cumulative proportions of the first three principal components, the “level” changes seem to explain the yield curve movements far better than the “ratio” changes in the case of the JPY (96.1% vs. 38.3%) and CHF (97.2% vs. 41.9%), and they are only marginally worse for the USD (97.7% vs. 98.5%) and GBP (96.5% vs. 98.3%). In all markets, the explanatory power (proportion) of the first PC (PC1) is over 82%, and most of the movements can be explained by it. Furthermore, the explanatory power (cumulative proportion) from PC1 up to the third PC (PC3) is over 96%. Thus, it can be considered that most of the movements can be explained by the first three PCs. In addition, we investigate whether there is a structural change in yield curve movements before and after the global financial crisis of 2007–2008 (GFC). If we use daily “level” changes for the PCA, the GFC has no impact on the yield curve movements for all major currencies. The three PCs retain good explanatory power.

Citation

Takahashi, T. (2022), "Measuring Yield Curve Movements: A Principal Component Analysis of Spot Rate Changes in the JPY, USD, GBP, and CHF Interest Rate Swap Markets", Lee, C.-F. and Yu, M.-T. (Ed.) Advances in Pacific Basin Business, Economics and Finance (Advances in Pacific Basin Business, Economics and Finance, Vol. 10), Emerald Publishing Limited, Leeds, pp. 193-208. https://doi.org/10.1108/S2514-465020220000010011