Author : Jaeho Yun(Ewha Womans University), Dowan Kim(Bank of Korea), Hyungsuk Lee(Bank of Korea)

<Abstract>

This paper examines the evolving pattern of co-movement between Korean and U.S. long-term interest rates, along with its underlying sources, using three complementary approaches: an analysis of daily yield data, a Gaussian dynamic term structure model (GDTSM), and an event study centered on major Federal Reserve policy announcements. First, the daily data reveal that the realized covariance between Korean and U.S. long-term yields rose sharply in the immediate aftermath of the 2008 global financial crisis and again during the global inflation shock beginning in 2021. Realized volatilities in both countries also spiked during these episodes, indicating that co-movement arises not only in the direction of yield changes but in their volatility as well. Second, the GDTSM analysis identifies the global inflation shock as the single largest contributor to co-movement. Decomposing the transmission into a policy channel and a risk compensation channel, we find that external shocks are conveyed to Korean long-term yields primarily through expectations of future central bank policy rather than through adjustments in risk compensation. Unconventional monetary policy by the Federal Reserve, including quantitative easing, likewise emerges as a significant source of co-movement. The event study shows that Korean short- and long-term yields declined significantly around major quantitative easing announcements, with the decline in long-term yields attributable more to the expectations component than to the term premium. Taken together, these findings indicate that the co-movement of Korean and U.S. long-term yields reflects the transmission of common external shocks — global inflation in particular — and the Federal Reserve's policy response to them, operating chiefly through the policy channel. This suggests a need to monitor closely how external shocks affect domestic interest rate determination and financial stability through this channel, while managing the expectations channel in a stable manner through communication with the market.