Interest rate risk factors in the Australian bond market

This paper reports the results of an empirical analysis of the nature of the factors that explain changes in Australian bond market yields. Consistent with overseas studies it is found that three factors are sufficient to explain most of the historical yield curve variation in Australia. These factors can be interpreted as a parallel shift factor, a slope factor and a curvature factor. Although one factor interest rate models are often used to price and hedge interest rate dependent claims it is clear that, at least for hedging purposes, a two or three factor model will be essential.