A regression and comparative study of United States and South African yield curves using principal component analysis

Abstract

Volatile markets and economic environments can significantly distort the shape and smoothness of yield curve movements. This study explores the influence of movements in United States interest rates on South African interest rates. This study aims to identify the main underlying movements present in the United States and South African yield curves and to further determine the dominant factors that are responsible for driving South African interest rate movements. The principal settings for the study were the United States and South African markets representing, respectively, a developed and developing market. Principal component analysis was used to discern the major drivers of developing and developed market interest rates. The findings show that the principal component analysis technique is able to effectively classify and quantify the movements of yield curves across both markets in terms of three main factors, namely level, slope and curvature shifts. During certain periods, South African yield curve changes were largely driven by variations in United States interest rates and the rand/dollar exchange rate. Results also demonstrated that a volatile market and economic environment can significantly distort the shape and smoothness of yield curve movements.