Estimating Term Structure Changes Using Principal Component Analysis in Indian Sovereign Bond Market

This paper analyses the India sovereign yield to find out the principal factors affecting the term structure of interest rate changes. We apply Principal Component Analysis (PCA) on our data consisting of zero coupon interest rates derived from government bond trading using Nelson-Siegel functional form. This decomposition of the yield curve highlights important relationship between identified factors and metrics of the term structure shape. The results indicate that the three factors provide us the most of the variations in the term structure shift in India market. The study finds that the first three principal components explain a major part of the total variance of interest rate changes. This result is consistent with other studies. The first factor accounts for 76.87% of the total variance, while the second and third factors account for 16.64% and 5.14%, respectively. In sum, the first three principal components explain 98.64% of the variability of the data, which indicates that these factors are sufficient for describing the changes in the term structure in India.The empirical findings support statistical similarities between the Indian yield curve and term structure studies of major countries