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A Term Structure Decomposition of the Australian Yield Curve*


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    The authors thank Meredith Beechey, Adam Cagliarini, Jonathan Kearns, Christopher Kent, Kristoffer Nimark and Anthony Richards for useful comments and suggestions. Responsibility for any remaining errors rests with the authors. The views expressed in this paper are those of the authors and are not necessarily those of the Reserve Bank of Australia.

Richard Finlay and Mark Chambers, Reserve Bank of Australia, GPO Box 3947, Sydney, NSW 2001, Australia. Email: or


We use data on coupon-bearing Australian Government bonds and Overnight Indexed Swap (OIS) rates to estimate risk-free zero-coupon yield and forward curves for Australia from 1992 to 2007. These curves and analysts’ forecasts of future interest rates are then used to fit an affine term structure model to Australian interest rates, with the aim of decomposing forward rates into expected future overnight cash rates plus term premia. The expected future short rates derived from the model are on average unbiased, fluctuating around the average of actual observed short rates. Since the adoption of inflation targeting and the entrenchment of low and stable inflation expectations, term premia appear to have declined in levels and displayed smaller fluctuations in response to economic shocks. This suggests that the market has become less uncertain about the path of future interest rates. Towards the end of the sample period, term premia have been negative, suggesting that investors may have been willing to pay a premium for Commonwealth Government securities.