Advances in Economics and Business Vol. 5(7), pp. 411 - 422
DOI: 10.13189/aeb.2017.050704
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The Twist Factor of Yields


Xuyang Ma *
PanAgora Asset Management, USA

ABSTRACT

The twist factor is the fourth latent yield factor following the level, slope, and curvature factors. In this paper, we obtain a four factor composed model with an additional "twist" factor based on the three factor composed Nelson-Siegel model. Specifically, we derive the kernel function for the twist factor and use it to fit the in-sample yields and to forecast future yields. We show that, the twist factor derived within the Nelson-Siegel framework has comparable variance with the curvature factor and helps reducing the fitting errors both in-sample and out-of-sample. Furthermore, we derive portfolios using future yields and yield factors forecasts. The twist factor performs the second best following the slope factor in terms of Sharpe Ratio of formed portfolios.

KEYWORDS
Yield Factors, Nelson-Siegel Model, The Twist Factor, Factor Model, Portfolio Construction, Out-of-sample Forecast Evaluations

Cite this paper
Xuyang Ma . "The Twist Factor of Yields." Advances in Economics and Business 5.7 (2017) 411 - 422. doi: 10.13189/aeb.2017.050704.