Bond Trading and Yield Curve Network
https://www.bloomberg.com/graphics/2019-yield-curve-inversions/
A US treasury bond is an agreement with the federal government where you purchase a bond for a certain amount, and the government pays you interest based on the bond’s length. It is similar to loaning money to the government in a contract. In a normal situation, the longer the bond length is, the higher the interest rate on the bond. Bonds are also primarily traded in the secondary market, where demand dictates the price of the bond. From this, the demand changes on a daily basis the the cost of purchasing bonds and the amount of money you can make changes.
In a graph of the time to maturity of the bond as the x-axis and the yield as the y-axis, the yield curve is produced, and the points represent the corresponding returns or yield with the term to maturity. The demand for the bonds can be changed based on investor confidence in the markets and how investors believe the markets in the future will perform. If investors suspect a recession or a not so strong economy, the demand for a lower term to maturity bond will decrease since the state of the markets is non optimal when investors receive their money from the bond. When the demand decreases, the price decreases, which means higher return percentage on the same bond. Similarly, the demand for longer term to maturity bonds increase when investors believe there will be a better economic state in the future, so their demand shifts to longer, safer investments. That decreases the price and the yield of the bond decreases. In a normal situation, the yield curve has an upwards slope, but in times when investors fear an economic recession, the yield in longer term to maturity bonds decrease while yields in shorter term to maturity bonds increase. When the yield curve inverts, this is a possible indicator of a recession.
The market of bonds and the network of trading represents a core part of graph theory. The idea of how nodes are connected with edges in different components, or more specifically social networks, ties in with information exchange within traders. Each node represents someone in the network within bond trading, and the edge represents trades being made or travel of information. There is an equilibrium point that changes often but acts as the intersection of supply and demand for the price of a bond, which dictates the bond yield, when investors will not gain anything from changing their position. Another important aspect of this network is that individuals will act with expectation that others in the network will react to it, specifically that the prices of bonds change with the demand. At the same time, behavior in the network can be said to align with neighbors of the network, similar to a cascading effect. The interactions in a social network dealing with trading are very complex, but studying networks such as these at a smaller level allow for identification of key elements. Will there be a recession in the near future? Can the network structure and the way that bonds are priced tell?