Term structure of interest rates

Abstract

A zero coupon yield curve (ZCYC) or the term structure of interest rate for debt market defines the relationship among the market interest rates with instruments of different maturities at a particular time period. The estimation of term structure of interest rates for the Indian debt market has been possible only after the financial liberalisation that started in the early nineties. Abolition of administered interest rates, introduction of liquidity adjustment facility in Junand#8223;2000 and a series of other reform measures had a profound impact on market depth and liquidity as reflected in sharp rise in market turnover. There have been some studies for the valuation of term structure of interest rates for India. However, no studies are found that looked into the macro aspects of the yield curve holistically in the Indian scenario. The aim of the thesis is to examine if the term structure of interest rates can be used as a leading indicator for forecasting future path of inflation or real activity in India along with monetary policy. The thesis starts with providing an overview of economic scenario during the pre and post reform periods. It discusses in detail several reform measures adopted by Reserve Bank of India (RBI) to develop deep and liquid secondary markets in government securities in India. The study provides literature survey of estimation of term structure of interest rates and its macroeconomic applications in both developed and emerging economies highlighting its unique contribution to the literature. To address the predictive contents of term structure of interest rates, a well-defined or a reliable estimation of term structure of interest rates is required for the Indian market as redemption yields provided by the RBI significantly underestimates the true steepness or the valuation of the yield curve. The thesis intends to understand the bidirectional dynamic linkages from yield curve and the key macro factors, namely inflation and growth in the presence of monetary policy.