Mats Levander: Yield Curve Modeling under Cyclical Influence

There are few models for long-term yield forecasting and especially in the Real World Measure. This thesis uses Principal Component Analysis (PCA) to analyze the yield curves and gives an update of precedent studies. The conclusion is still that the first three components are enough to describe the variation of the yield curve. For simulation of the yield curves, PCA and a semi-parametric approach are evaluated. These models fail to yield plausible simulations. Therefore a new model is developed. The model is influenced by a business cycle, and a relationship is derived from historical data between the yield curve and the cycle. Nelson-Siegel's model and Ornstein-Uhlenbeck processes are some of the features used in the model. Tools are also introduced to cope with the non-negativity problems in the aftermath of the financial crisis. The model will be used as input to calculate the Swap Breakage Exposure upon an early termination of an interest rate swap.