Riding the Yield Curve

Abstract

Riding the yield curve, the fixed-income strategy of purchasing a longer-dated security and selling before maturity, has long been a popular means to achieve excess returns compared with buying and holding, despite its implicit violations of market efficiency and the pure expectations hypothesis of the term structure. This article looks at the historic excess returns of different strategies across three countries and proposes several statistical and macro-based trading rules that seem to enhance returns even more. Although riding based on the Taylor rule works well even for longer investment horizons, the empirical results indicate that using expectations implied by Fed funds futures, excess returns can only be increased over short horizons. Furthermore, the authors demonstrate that duration-neutral strategies are superior to standard riding on a risk-adjusted basis. Overall, the evidence here stands in contrast to the pure expectations hypothesis and points to the existence of risk premia that may be exploited consistently.

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