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JOURNAL OF APPLIED BUSINESS AND ECONOMICS
Canadian Interest Rates and Yield Spread Dynamics
Author(s): Ilona Shiller
Citation: Ilona Shiller, (2012) "Canadian Interest Rates and Yield Spread Dynamics," Vol. 13, Iss. 3, pp. 11 - 24
Article Type: Research paper
Publisher: North American Business Press
Abstract:
We apply two commonly used cointegration techniques to study the relation between corporate yields and
government yields and derive implications for the relation between yield spreads and government yields.
Due to the stationary nature of the yield spread data, based on results of the conventional unit root tests,
we cannot use cointegration theory to test this directly. The results of the unrestricted impulse response
analysis provide evidence, which contradicts the results of cointegration analysis applied to corporate
and government yields. Our expectation of a positive long-run relation between yield spreads and
government yields is only slightly realized for AA yield spreads. The effect of a shock to the 10-year
government yield appears to have a consistently negative impact on A and BBB yield spreads, both over
the short-run and the long-run. The negative yield spread - government rate relation is induced due to the
over-representation of callable bonds in the sample of bond indices. Moreover, yield spreads appear to
exhibit characteristics similar to long-memory processes, for which the order of integration lies between
zero and one. The hypothesis of fractional integration has to be tested using a completely different set of
statistical tools and is not examined in this paper.
