Escape from arbitrage: the movie

Two of my favorite economists, Bilkent University Professor Refet Gurkaynak and Johns Hopkins University Professor Jonathan Wright, have a nice new paper in which they survey macroeconomic theories of the term structure of interest rates. As an unusual digital supplement to their paper, they put together a movie in which you can watch the arbitrage glue that normally holds markets together start to fail as financial markets literally fell apart at the end of 2008.

What you’re watching in the movie are the yields to maturity (vertical axis) of different Treasury securities as a function of time to maturity (horizontal axis) as we move from one day to another over the last two years. We start out 2008 with securities of similar maturities offering very similar yields, as of course standard no-arbitrage finance theory says they should. But watch that nice relation fall apart as yields (and everything else) started tumbling down at the end of 2008. Gurkaynak and Wright have a discussion of this on page 39 of their paper.

Click here to watch the movie.


10 thoughts on “Escape from arbitrage: the movie

  1. Johannes

    Paper is quite interesting.
    Related to page 2, statement by Greenspan in 2005 :
    Greenspan thought this chaotic system is linear in its behaviour (at all time). Must be a funny guy, this Mr. Greenspan.

  2. ppcm

    Few years after the conundrum was revisited:
    UBS,HSBC,CS fired their bonds dealers as they were not complying with the primary dealers duties, that is to ensure the liquidity of the secondary market.The retention of primary issues by primary dealers became too obvious.
    In Frankfurt in 2007 or 2008? 4 dealers of Citi banks were fired for selling Bunds at…………lunch time and consequently depressing prices and expanding the interest rates.
    In Boston a UBS offspring was visited by the SEC as they had the misfortune of sheltering hedge funds and government bonds fresh issues at the same time.
    All above facts related either by Bloomberg or Fortune magazine are no longer traceable through Google.In Europe nothing comparable was reported and yet the interest rates of government issues were following the same path.
    The OOCC,BIS statistics are supplying enough evidences of the prices distortion mechanic.
    If risks premia and pricing kernel are still relevant and agents are risk adverse, then let us have a look at the latest issue of the ECB statistical table P7 (june 2010) :
    On 15.7 trillion euros debts issues 9.7 trillion euros are issued by financial institutions or assimilated, where general governments are adding an other 6.187 trillion euros (mainly related to bails out) and the non financial corporations 861.8.The risk adversity is far from being factored in the debts prices issues.
    Euro area securities issues statistics June 2010.
    My main question remains, as it lies beyond financial and material consideration what kind of civilization are we led to ?

  3. Steve Bannister

    I love animated scatterplots!
    BTW, Jim, you may already know, but Aruoba and Diebold are at it again!!!! This time with the whole world as their oyster:
    We propose and implement a framework for characterizing and
    monitoring the global business cycle. Our framework utilizes
    high-frequency data, allows us to account for a potentially large
    amount of missing observations, and is designed to facilitate the
    updating of global activity estimates as data are released and
    revisions become available. We apply the framework to the G-7
    countries and study various aspects of national and global business
    cycles, obtaining three main results. First, our measure of the
    global business cycle, the common G-7 real activity factor, explains
    a significant amount of cross-country variation and tracks the major
    global cyclical events of the past forty years. Second, the common
    G-7 factor and the idiosyncratic country factors play different roles
    at different times in shaping national economic activity. Finally,
    the degree of G-7 business cycle synchronization among country
    factors has changed over time.”

  4. RebelEconomist

    Yes, a fascinating way to present the data, but academic economists should be wary of how they interpret it. Two bonds might be of similar maturity and even coupon, but their micro characteristics can make them trade at very different yields for reasons which make sense when you know what they are. For example, one of the better known differences is whether bonds of a similar maturity are on or off the run, which affects their repo earning value and their liquidity, but there are many other more obscure factors. I learnt this the hard way managing a treasury bond portfolio in the 1990s, and I would imagine that you could make a similar movie for late 1998. I know its not the sort of thing that makes for acclaimed academic publications, but in my experience, if you really want to get to the bottom of such apparent anomalies, ask an experienced treasury trader at a market maker with a large market share.

Comments are closed.