Dynamics of the Shape of the Yield Curve

The shape of the yield curve, its steepness and curvature, is influenced by market expectations, required bond risk premiums, and convexity bias. The authors examine empirical research to discern the relative importance of each factor in determining yield curve shape. They find empirical evidence suggesting that curve steepness is related to required bond risk premiums, which vary with time, and that curvature is related to convexity bias and investor preference for barbell portfolios. The authors also find empirical evidence inconsistent with one-factor term structure models.