An investigation of the effect of funding on the slope of the yield curve

Market practitioners often have a firm view that funding operations have clearly observable effects on the slope of the yield curve. The standard theory of the expectations model of the yield curve, however, suggests that the sole determinant of the slope of the yield curve is expectations of future short-rates and so funding policy, ceteris paribus, should have no effect. This paper develops a high frequency set of data for the UK yield curve. Principal components are used to decompose the yield curve into a set of factors which represent the level of returns, the slope of the curve and higher order effects. The paper concentrates on the determinants of the second principal component as a measure of the slope and use a GARCH-M model to investigate the effects of funding on this variable. Strongly significant effects are found from the stock of government bonds of varying maturity bands on the slope of the yield curve. This supports the practitioners view and argues that factors such as market segmentation are more important than simple theories might suggest.