Intelligible Factors for the Yield Curve

We construct a factor model of the yield curve and specify time series processes for these factors, so that the innovations are mutually orthogonal. At the same time, the factors are constructed in such a way that they assume clear, intuitive interpretations. The resulting "intelligible factors" should prove useful for investment professionals to discuss expectations about yield curves and the implied dynamics. Moreover, they allow us to distinguish announced changes of the monetary policy stance versus monetary policy surprises, which are ctually rare. We identify two such events, namely September 11, 2001, and the Fed reaction to the recent subprime crisis.