We examine empirically the co-movements of market rates between Korea
and the U.S., focusing on the yield curve, driven by the large-scale
quantitative easing carried out by major advanced countries since the global
financial crisis. We extract major factors from the Korean and U.S. yield
curves by employing the dynamic Nelson-Siegel model. After establishing a
time-varying parameter VAR model, which deploys these factors as variables,
we conduct a forecast-error variance decomposition analysis from a dynamic
perspective. Our main results confirm that the effects of the U.S. yield curve’s
level factors on those of Korea have grown significantly since the global
financial crisis. This is particularly true for the impact of U.S. long-term
interest rates on three-year Korean government bond yields, as its explanatory
power exceeded 40% in 2014. Meanwhile, as for Korean short-term interest
rates, we do not find any significant effects of U.S. long term interest rates.
Our findings suggest that Korean long-term interest rates are likely to face
upward pressures from the rise in US long-term interest rates following the
monetary policy normalization by the Federal Reserve Board. This may
increase the volatility of Korean financial market by, for example, widening the
spread between short- and long-term interest rates, which would in turn cause
Korean yield curve to steepen. It is thus important to devise relevant policy
measures in response.