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Pricing the term structure with linear regressions

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  • Adrian, Tobias
  • Crump, Richard K.
  • Moench, Emanuel

Abstract

We show how to price the time series and cross section of the term structure of interest rates using a three-step linear regression approach. Our method allows computationally fast estimation of term structure models with a large number of pricing factors. We present specification tests favoring a model using five principal components of yields as factors. We demonstrate that this model outperforms the Cochrane and Piazzesi (2008) four-factor specification in out-of-sample exercises but generates similar in-sample term premium dynamics. Our regression approach can also incorporate unspanned factors and allows estimation of term structure models without observing a zero-coupon yield curve.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 110 (2013)
Issue (Month): 1 ()
Pages: 110-138

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Handle: RePEc:eee:jfinec:v:110:y:2013:i:1:p:110-138

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Web page: http://www.elsevier.com/locate/inca/505576

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Keywords: Term structure of interest rates; Fama-MacBeth regressions; Dynamic asset pricing estimation; Empirical finance;

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Citations

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Cited by:
  1. Alexander Guarín & José Fernando Moreno & Hernando Vargas, 2014. "An Empirical Analysis of the Relationship between US and Colombian Long-Term Sovereign Bond Yields," Borradores de Economia 822, Banco de la Republica de Colombia.
  2. Tobias Adrian & Daniel Covitz & Nellie J. Liang, 2013. "Financial stability monitoring," Staff Reports 601, Federal Reserve Bank of New York.
  3. Dániel Horváth & Péter Kálmán & Zalán Kocsis & Imre Ligeti, 2014. "What factors influence the yield curve?," MNB Bulletin, Magyar Nemzeti Bank (the central bank of Hungary), Magyar Nemzeti Bank (the central bank of Hungary), vol. 9(1), pages 28-39, March.
  4. Tobias Adrian & Erkko Etula & Jan J. J. Groen, 2010. "Financial amplification of foreign exchange risk premia," Staff Reports 461, Federal Reserve Bank of New York.
  5. Peter Spencer, 2013. "The US Economy, the Treasury Bond Market and the Specification of Macro-Finance Models," Discussion Papers 13/22, Department of Economics, University of York.
  6. Eric Ghysels & Casidhe Horan & Emanuel Moench, 2012. "Forecasting through the rear-view mirror: data revisions and bond return predictability," Staff Reports 581, Federal Reserve Bank of New York.
  7. Hyun Song Shin & Erkko Etula & Tobias Adrian, 2010. "Risk Appetite and Exchange Rates," 2010 Meeting Papers 311, Society for Economic Dynamics.
  8. Emanuel Moench & James Vickery & Diego Aragon, 2010. "Why is the market share of adjustable-rate mortgages so low?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, Federal Reserve Bank of New York, vol. 16(Dec).
  9. Olena Chyruk & Luca Benzoni & Andrea Ajello, 2012. "Core and `Crust': Consumer Prices and the Term Structure of Interest Rates," 2012 Meeting Papers, Society for Economic Dynamics 922, Society for Economic Dynamics.
  10. Miguel A. Segoviano Basurto & Carlos Caceres & Vincenzo Guzzo, 2010. "Sovereign Spreads," IMF Working Papers 10/120, International Monetary Fund.
  11. Juneja, Januj, 2014. "Term structure estimation in the presence of autocorrelation," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 119-129.
  12. Antonio Diez de los Rios, 2013. "A New Linear Estimator for Gaussian Dynamic Term Structure Models," Working Papers 13-10, Bank of Canada.
  13. Alexander Guarín & José Fernando Moreno & Hernando Vargas, 2014. "An empirical analysis of the relationship between US and Colombian long-term sovereign bond yields," BIS Papers chapters, in: Bank for International Settlements (ed.), The transmission of unconventional monetary policy to the emerging markets, volume 78, pages 129-158 Bank for International Settlements.
  14. Michael Abrahams & Tobias Adrian & Richard K. Crump & Emanuel Moench, 2012. "Pricing TIPS and treasuries with linear regressions," Staff Reports 570, Federal Reserve Bank of New York.
  15. Phurichai Rungcharoenkitkul, 2011. "Risk Sharing and Financial Contagion in Asia," IMF Working Papers 11/242, International Monetary Fund.
  16. Rebecca Hellerstein, 2011. "Global bond risk premiums," Staff Reports 499, Federal Reserve Bank of New York.
  17. Stijn Van Nieuwerburgh & Hanno Lustig & Ralph S.J. Koijen, 2009. "The Bond Risk Premium and the Cross-Section of Equity Returns," 2009 Meeting Papers, Society for Economic Dynamics 12, Society for Economic Dynamics.
  18. Tobias Adrian & Erkko Etula & Hyun Song Shin, 2009. "Global liquidity and exchange rates," Staff Reports 361, Federal Reserve Bank of New York.
  19. Durham, J. Benson, 2013. "Another view on U.S. Treasury term premiums," Staff Reports 658, Federal Reserve Bank of New York.
  20. Tobias Adrian & Erkko Etula, 2010. "Funding liquidity risk and the cross-section of stock returns," Staff Reports 464, Federal Reserve Bank of New York.
  21. Erkko Etula, 2009. "Broker-dealer risk appetite and commodity returns," Staff Reports 406, Federal Reserve Bank of New York.
  22. Fricke, Christoph, 2012. "Expected and unexpected bond excess returns: Macroeconomic and market microstructure effects," Hannover Economic Papers (HEP) dp-493, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.

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