RDP 2008-09: A Term Structure Decomposition of the Australian Yield Curve 6. Conclusion

We have used data on coupon-bearing Australian Government bonds and OIS rates to estimate risk-free zero-coupon yield and forward curves for Australia from 1992 to 2007. These curves, and analysts' forecasts of future interest rates, were then used to fit an affine term structure model to Australian interest rates, with the aim of decomposing forward rates into expected future short rates and term premia.

The model produces plausible results, although given the complexity of the model and the difficulty of calibrating it to the data, a false level of precision should not be attributed to the results. The results show a large and sustained fall in term premia from around 1996 to 2007, when inflation credibility became more entrenched and so inflation expectations declined. This period displays relatively low inflation, stable economic growth and stable bond yields.

The model suggests that there have been small negative term premia for some periods. The finding of negative term premia has been a global phenomenon during the early to mid 2000s, as seen in the decline in long-term interest rates. This could reflect the widely discussed ‘search for yield’ that occurred over this period, or may be explained by an over-shooting of bond yields. In Australia's case, the relatively low supply of government bonds, which has tended to fall over the period considered, may have contributed to negative term premia as risk-averse and mandate-constrained investors bid up the price of these bonds.

Notwithstanding the above discussion, the results seem to imply that expected future short rates are relatively stable in Australia. The results also imply that, based on expectations of future monetary policy, yields on government bonds have been lower than might be expected, with term premia attached to these bonds consequently being negative, at least towards the end of our sample period.