Hi,I am trying to put together an economic "fair value" model for US yields, in particular the 2yr and 10yr points on the curve. The factors I have considered so far include inflation, real short rates, budget balance, and growth. I have attempted various specifications of linear regression on historical data to define the equilibrium relation between 2yr/10yr yields and those factors.Should I be looking at other/additional factors? What would the best methodology to achieve this?Does anyone have any such model or can recommend relevant literature?Many thanksSpirotula

Hi mate,really u try to explain the possible reasons for the 10-2y spd?

Yes, I am hoping to develop an equilibrium bond yield model so I can have a fair value for the key Treasury yields based on economic factors (as opposed to building a theoretical curve from forwards/futures/swaps etc). This will also shed light on the 2-10y spread.Any ideas?Thanks!

To get a feel for the 2y10y curve spread you could look at other curve spreads around (or in between the 2y10y). For example the 6.5y30y spread, the 3y5y spread and the 3mo3y spread.

ok, thanks. However, how about trying to come up with some sort of economic explanation behind the yield levels/spread? Essentially, I am seeing this as performing some sort of principal components analysis on yields, so I am looking for what my specification and components should be...

QuoteOriginally posted by: spirtoulaHi,I am trying to put together an economic "fair value" model for US yields, in particular the 2yr and 10yr points on the curve. The factors I have considered so far include inflation, real short rates, budget balance, and growth. I have attempted various specifications of linear regression on historical data to define the equilibrium relation between 2yr/10yr yields and those factors.Should I be looking at other/additional factors? What would the best methodology to achieve this?Does anyone have any such model or can recommend relevant literature?Many thanksSpirotulaOne approach to this problem would be to start with existing economic theories of the yield curve. This gives you the benefit of being able to access the literature, which enables you to see how other people have solved the problems and to see what results they got. The three main economic theories of the yield curve are (1) inflation expectations, (2) liquidity preference and (3) clientele niches. None of these three (expectations, preferences, clientele niches) are directly observable, so a major part of your modelling exercise is to find intelligent (rather than arbitrary) proxies for these factors. Any economics text book will discuss these theories and point you in the direction of empirical econometric research.Once you have built a model based on the standard theories, you should then add your own insights to it by considering which factors are currently driving bond yields. One obvious contender at the moment is the effect of (Asian) central banks in buying US bonds. Once again, a major part of your analysis will be trying to find proxies for these additional factors.