Joint affine term structure models: Conditioning information in international bond portfolios

In this paper, we propose a simple model for international bond investment. The investor can optimize a government bond portfolio in a discrete time horizon conditional on the common and local factors in international bond returns. The variation in the cross section and time series of treasury yields is captured by a joint affine term structure model (ATSM). Easy closed form solutions for the returns and variances are given. We test our model in an empirical study of US and UK government bonds in the period of 1983 to 2012. An interpretation of the common factors as ’level’, ’slope’ and ’spread’ not only helps to interpret the cross section and time series of the treasury yields but also to understand the evolution of our conditional portfolio weights. Our empirical study shows that common factors in international bond returns are not only an empirical phenomenon. The empirical findings can be supported by the proposed model and the model can link the investor’s decision conditional on the common factors in international bond returns.