Updating the Yield Curve to Analyst’s Views

Abstract

Fixed income analysts are accustomed to monitoring a few benchmark yields on a continuous basis and providing point estimates for these yields, or for a combination of them. Yet, the optimization of fixed income portfolios requires an accurate forecast of not only a few benchmark yields, but of complete yield curves. This chapter derives a forecast of one or more yield curves that is consistent with analysts’ views. The model is based on a novel application of principal component analysis (PCA). It can be extended to other markets and has no restrictions on the number of forecast variables, or the number of views. We consider examples of forecasting the government bond yield curves of the US, the Eurozone and the UK, simultaneously or not.