Yield curve
Quantitative Finance glossary · Quantitative Finance
Definition
Function relating yield to maturity, the basis for extracting discount factors and forward rates. Three economic shapes: normal (upward — positive term premium), inverted (downward — recession signal, ten-out-of-ten US recessions since 1955 preceded by 2s10s inversion), and flat. Decomposable into level, slope, and curvature factors (PCA), which together explain ≥ 95% of variance. Built today via multi-curve bootstrapping (OIS/SOFR discount + per-tenor forecasting curves); the choice of interpolation (linear-on-rates, cubic-spline, monotone-convex) materially affects implied forward rates.
Yield curve in plain English
A yield curve is just a graph showing the interest rate you earn for lending money for different lengths of time — a few months, a year, ten years, thirty years. Normally longer loans pay a bit more (you're tying up your money longer, so you want extra), giving an upward slope; but when short-term rates are HIGHER than long-term ones (an 'inverted' curve), it has famously warned of every US recession since 1955, because it signals investors expect the economy to slow. It's the master ruler of finance: from it you can read off what a future dollar is worth today and what rates the market expects down the road. In practice banks build it from many market prices at once, and even the fine detail of how you connect the dots between known points can noticeably change the future rates it implies.
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