- The term structure of the Yield Curve is one of the most essential tools in financial economics. All agents, both government and private firms, set them as a benchmark for implementing their policy and business decision, respectively. The yield curve can be one of the reasons for prosperous firms/countries or their declines (as evident in 2023)
- This paper aims to understand the characteristics of Indonesia’s government bond yield curve, to forecast the curve for 2024 and to assess its future trajectories/volatilities. It’s divided into two parts: dissecting and predicting the yield curve (Economic Bulletin – Issue 44) and exploring its interaction with various shocks (Forthcoming).
- The importance of understanding the yield curve extends beyond its movement. The spread between long-term and short-term yields, especially the 10-year and 2-year government bonds, provides valuable insights into economic growth and potential recession risks, a concept widely monitored in financial economics.
- This paper employs both Machine Learning and Parsimonious models (particularly Dynamic Nelson Siegel based models) to estimate Indonesia’s 2024 yield curve.
- After thorough examination and comparison, we found that Random Walk model is still ‘the king’ for short horizon (particularly 1 month horizon), while our models exhibit better performance in medium to long horizon (in line with Duffee (2002), Diebold and Li (2006) & Rubín and Ayliffe (2020))
- Based on two of our best-performing models, Indonesia’s government bond for 2-year maturity will hover around 5.7% to 6.4%, 5-year maturity at ±6.5%, and 10-year maturity at 6.6% – 6.9%
- Predictions for 2024 indicate two possible scenarios: a flattening curve akin to 2023’s trend or a normalizing curve. These outcomes are influenced by critical factors such as Policy Rate and Exchange Rate, with the total government debt and its structure playing a significant role.
Toward Stronger Financial Industry in Indonesia