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Why common factors in international bond returns are not so common

Authors
Journal
Journal of International Money and Finance
0261-5606
Publisher
Elsevier
Publication Date
Volume
26
Issue
2
Identifiers
DOI: 10.1016/j.jimonfin.2006.11.006
Keywords
  • Bond Returns
  • Factor Analysis
  • Principal Component Analysis

Abstract

Abstract This paper analyzes the common factor structure of US, German, and Japanese Government bond returns. Unlike previous studies, we formally take into account the presence of country-specific factors when estimating common factors. We show that the classical approach of running a principal component analysis on a multi-country dataset of bond returns captures both local and common influences and therefore tends to pick too many factors. We conclude that US bond returns share only one common factor with German and Japanese bond returns. This single common factor is associated most notably with changes in the level of domestic term structures. We show that accounting for country-specific factors improves the performance of domestic and international hedging strategies.

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