FM for Actuaries

232 CHAPTER 7
7.7 Term Structure Models
We have shown some samples of the yield curves of the US market in Chapter
3. Empirically the yield curve can take various shapes. Figure 7.3 presents the
term structure of the UK market monthly from January 2002 through December
2015. Likewise, Figure 7.4 summarizes the term structure of the US market for
the same period. It can be seen that the term structures took quite different shapes
during this period. For the US market the yield curve was mostly upward sloping
from 2002 through 2004. It showed inverted humps in parts of 2005 and 2006,
while in 2007 and 2008 it was generally quite flat, even showing slightly downward
slopes at long maturities. The US Federal Reserve has held short-term interest rates
around 0.25% after the global financial crisis. The US yield curve has been mostly
upward sloping after 2008. In comparison, the UK market showed more frequent
occurrences of downward sloping yield curves. However, similar to the US market,
it also experienced several years of rather steep normal yield curves in the early
parts of the 2000s. It will be interesting to examine the factors determining the
shapes of the yield curve, how the yield curve evolves over time, and whether the
shape of the yield curve has any implications for the real economy such as the
business cycle.
Figure 7.3:
Historical UK spot-rate curves
(Source: Bank of England, www.bankofengland.co.uk)