Decomposition of Brazil's 5-year DI Futures in Basis Points

TL;DR

This paper introduces an interpretable, empirical framework to decompose daily changes in Brazil's 5-year DI futures rate into macroeconomic, fiscal, and sovereign risk components, explaining about 22.45% of the variance.

Contribution

It develops a novel, transparent decomposition method combining macro expectations, macro factors, and sovereign risk regressions, specifically tailored for Brazil's DI futures.

Findings

Domestic risk dominates the explained variance.

Macro expectations contribute significantly but less than domestic risk.

Large residual indicates limits of linear models and missing drivers.

Abstract

This paper proposes an empirical, replicable, and interpretable framework to decompose, in basis points (bps), daily changes in Brazil's 5-year DI futures rate (DI5Y). The approach combines three building blocks: (i) macroeconomic and fiscal expectations from the Central Bank of Brazil Focus survey, converted into daily changes; (ii) a supervised macro factor built with Partial Least Squares (PLS) that summarizes changes in expectations together with a high-frequency macro "surprise" indicator; and (iii) a decomposition of sovereign risk using Brazil CDS into global and domestic components, obtained by regressing CDS on external financial conditions (DXY, CRB, VIX, and the US 10-year yield). The final step maps these drivers into daily bps contributions through a linear regression of the daily change in DI5Y on the three factors, producing a cumulative decomposition that adds up with an intercept and a residual. In the final sample (2015-01-13 to 2025-12-12; 2,741 observations), the model explains about 22.45% of the daily variance in DI5Y changes. The explained share is dominated by domestic risk, with a smaller but statistically significant contribution from the macro factor. The residual remains large, highlighting the limits of linearity and omitted drivers such as monetary policy event windows, term premia, liquidity, and positioning. Overall, the framework delivers a transparent accounting of how much of the daily (and cumulative) movement in DI5Y is associated with macro/central bank forces, domestic Brazil risk, and external risk.