Co-movements in international bond yields

So far we have only used principal component analysis to look at data within a single
country, to identify patterns of co-movement between yields at different maturities.
We derived the very useful result that two major kinds of co-movement explain most
variations in bond yields.
It is also possible to analyze data across countries, to identify patterns of comovements
between bond yields in different countries. For example, one could carry
out a principal component analysis of daily changes in 10-year bond yields for
various countries. Can any useful conclusions be drawn?
The answer is yes, but the results are significantly weaker. Figure 5.9 shows the
dominant principal component identified from three separate datasets: 1970–79,
1980–89 and 1990–98. As one might hope, this dominant shift is a kind of ‘parallel
shift’, i.e. a simultaneous shift in bond yields, with the same direction and magnitude,
in each country. In other words, the notion of ‘global duration’ seems to make sense:

the aggregate duration of a global bond portfolio is a meaningful risk measure, which
measures the portfolio’s sensitivity to an empirically identifiable global risk factor.
However, there are three important caveats. First, the ‘global parallel shift’ is not
as dominant as the term structure parallel shift identified earlier. In the 1990s, it
explained only 54% of variation in global bond yields; in the 1970s, it explained only
29%. In other words, while duration captures most of the interest rate risk of a
domestic bond portfolio, ‘global duration’ captures only half, or less, of the interest
rate risk of a global bond portfolio: see Figure 5.11.

Second, the shift in bond yields is not perfectly equal in different countries. It
seems to be lower for countries like Japan and Switzerland, perhaps because bond
yields have tended to be lower in those countries.
Third, the ‘global parallel shift’ is not universal: not every country need be included.
For example, it seems as if Australian and French bond yields did not move in step
with other countries’ bond yields in the 1970s, and did so only partially in the 1980s.
Thus, the relevance of a global parallel shift to each specific country has to be
assessed separately.
Apart from the global parallel shift, the other eigenvectors are not consistently
meaningful. For example, there is some evidence of a ‘USD bloc shift’ in which US,
Canadian, Australian and NZ bond yields move while other bond yields remain fixed,
but this result is far from robust.
To summarize, principal component analysis provides some guidelines for global
interest rate risk management, but it does not simplify matters as much as it did for
yield curve risk. The presence of currency risk is a further complication; we return
to this topic below.