The factors that explain long-term government bond yields in Israel and OECD countries

25/10/2021 |  Michelson Noam, Stein Roy
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Finacial Markets and Financial Stability
Abstract

In this paper, we analyze the long-term government bond yields in the OECD countries over time, and estimate a range of factors that impact these yields. These factors include demographic, economic, and financial variables. The main goal is to distinguish the impact from the various factors, which were divided into three groups: structural factors that impact the natural rate of interest, cyclical factors, and fiscal risk factors, which depend on the probability that countries will be able to service their debt. Using this model, we examine if credit ratings have additional information that is taken into account by investors. The findings indicate that the natural rate of interest declined significantly and that it is a cross-border factor, which has an impact due to the many demographic changes on long-term interest rates. We also found that the low inflation rate and the accommodative, unconventional, monetary policy are the main cyclical factors that have impacted on long-term interest rates in recent years. The variance in the development of fiscal risk factors in the countries is the main reason for relative changes among countries. With regard to credit ratings, we found that beyond the economic factors that were estimated, the credit ratings themselves do not have an impact on yield. However, ratings changes that indicate an increase in credit risk, as well as crossing the speculative-investment threshold (in both directions), have a significant effect.

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