Sunday, August 15, 2010

A new economics paper on the yield curve

Which Jim Hamilton points us to. It is going to be a slog for me to read, but I will.

Before I do, I can express my view on the yield curve. First, the yield curve for any economic good attempts to be minimum phase. What I mean is that internal to the firm or household, inventories are designed to minimize shortages. This means that phase differences between incoming and outgoing goods flow is minimized. In signal processing, we call this minimum phase, and this internal management shows up on the visible yield curve as a minimum phase curve, there are no inversion, no obvious arbitration opportunities.

Second thing I want to notice is that the negative term portion of the yield curve is missing. These are the "planned" losses, and would show up on the right side of the yield graph, which we never print. These do not show up because they are realized right away. Long bond losses  are taken as lower yields to the left on shorter period terms. We recognize long term losses right away, in the short term.

Hence, the curve we see is a compressed version of the full spectrum. Complex values disappear because of minimum phase, and negative terms folded over into absolute value terms on the positive side.  The bankers yield curve is a compressed representation of GDP over time, compressed to a precision that I think is biologically determined.

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