International bonds

Principal component analysis for international markets
All our analysis so far has used US data. Are the results applicable to international
markets? To answer this question, we analyze daily historical bond yield data for a
range of developed countries, drawn from the historical period 1986–96.
In broad terms, the results carry over. In almost every case, the fundamental yield
curve shifts identified by the analysis are a parallel shift, a slope shift and some kind
of curvature shift. Moreover, as shown in Figure 5.9, the relative importance of these
different yield curve shifts is very similar in different countries – although there is
some evidence that parallel shifts are slightly less dominant, and slope shifts are
slightly more important, in Europe and Japan than in USD bloc countries.
It is slightly worrying that Switzerland appears to be an exception: the previous
results simply do not hold, at least for the dataset used. This proves that one cannot
simply take the results for granted; they must be verified for each individual country.
For example, one should not assume that yield curve risk measures developed for
use in the US bond market are equally applicable to some emerging market.
Figure 5.10(a) shows the estimated form of a parallel shift in different countries.
Apart from Switzerland, the results are extremely similar. In other words, duration
is an equally valid risk measure in different countries.
Figure 5.10(b) shows the estimated form of a slope shift in different countries; in
this case, estimated slope shifts have been normalized so that the 3-year yield remains fixed and the 10-year yield moves by 100 bp. Unlike the parallel shift, there
is some evidence that the slope shift takes different forms in different countries; this
is consistent with the findings reported in Brown and Schaefer (1995). For risk
management applications it is thus prudent to estimate the form of the slope shift
separately for each country rather than, for example, simply using the US slope shift.
Note that parallel/slope correlation also varies between countries, as well as over
time.
Estimated curvature shifts are not shown, but they are quite different for different
countries. Also, breaking the data into subperiods, the form of the curvature shift
typically varies over time as it did with the US data. This is further evidence that
there is no stable ‘curvature shift’ which can reliably be used to define an additional
measure of non-parallel risk.