Academic journal article Academy of Accounting and Financial Studies Journal

Nonlinearities and Chaos in Bond Yield Movements

Academic journal article Academy of Accounting and Financial Studies Journal

Nonlinearities and Chaos in Bond Yield Movements

Article excerpt


There are many reasons to expect the possible influence of chaotic dynamics in bond yield movements, whether it is Fed's policies, institutional trading programs, or evolutionary dynamics in the economy at play. This study attempts to detect the presence of low dimensional deterministic chaos in bond yield movements by examining four bond market aggregates. Evidence indicates an earlier presence of deterministic nonlinearity in the corporate bond funds that appears to have disappeared in recent years. No such evidence is evident for Treasury bonds. To the individual investor, this paper ends with a heartening note that, at least during recent times, the examined bond markets seem to have provided fairly priced bonds.


Of late, chaotic and stochastic nonlinearities have been heavily investigated topics in the examination of capital markets. These studies are either fashioned as an investigation into the informational efficiency of capital markets or simply as an exercise in examining the predictability of capital markets. Very often the above two objectives complement each other in the conduct of an empirical investigation, but some recent theorists have posited that chaotic nonlinearities can exist even in informationally efficient markets (Grabbe, 1996). Many studies have examined equity markets (e.g., Kohers et al, 1997, Pandey et al, 1998, 1999), foreign exchange markets (Hseih, 1989, Pandey et al, 2000) and various economic aggregates (Brock et al, 1991) for latent chaotic and stochastic nonlinearities. However, very little evidence exists on bond market aggregates. This paper attempts to fill this void in the literature by investigating four bond market aggregates, two corporate, and two Treasury bond aggregates for latent deterministic nonlinearities.

The reasons to expect a nonlinear driving influence in bond yield movements can come from many sources. In as much as the Fed's actions in influencing interest rates have been responsive to economic conditions and not entirely discretionary, these responses may be explained by some deterministic patterns, perhaps nonlinear in nature. Hence, it is possible that the

Fed's policy decisions, and institutional traders' trading programs, induce some form of chaotic determinism in bond yield movements. Such processes have already been documented in the stock markets (Sias and Starks, 1997). Moreover, recent deliberations about viewing economies as evolutionary dynamical processes lend credence to the hypothesis that aggregate capital market behavior may be driven by a "vision of the future" (Grabbe, 1996) and hence may embody an underlying deterministic mechanism. In light of these recent developments, investigations of underlying chaotic deterministic mechanisms in capital market aggregates has taken on an increased significance.

Grabbe (1996) presents the possibility of self-organization of human societies, and thus by implication, of the economy, with a shared image or a vision of the future. At the singular level, this vision might be subconscious or nonexistent, but at the aggregate level such a vision might be discernible. In large capital markets, a large volume of the trading occurs while traders are speculating. They may not afford the luxury of acting late on any relevant news. Very often, the trader must anticipate other traders' moves and try to preempt such moves. As such, each trader must not just act on his or her expectations, but rather act on the anticipation of other traders' moves who themselves are trying to anticipate the first's and everyone else's moves and so on. Evolutionary dynamics provide a solution in the form of a spontaneous order involving dynamic feedback at a higher, or aggregate, level. Hence in the capital markets context, what appears to be competition amongst traders and institutions at the lower level, where expectations are generated, functions as co-ordination at the higher (global) level. …

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