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Challenges in macro-finance modeling

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  • Don H. Kim
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    Abstract

    This article discusses various challenges in the specification and implementation of "macro-finance" models in which macroeconomic variables and term structure variables are modeled together in a no-arbitrage framework. The author classifies macro-finance models into pure latent-factor models ("internal basis models") and models that have observed macroeconomic variables as state variables ("external basis models") and examines the underlying assumptions behind these models. Particular attention is paid to the issue of unspanned short-run fluctuations in macroeconomic variables and their potentially adverse effect on the specification of external basis models. The author also discusses the challenge of addressing features such as structural breaks and time-varying inflation uncertainty. Empirical difficulties in the estimation and evaluation of macro-finance models are also discussed in detail.

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    File URL: http://research.stlouisfed.org/publications/review/09/09/part2/Kim.pdf
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    Bibliographic Info

    Article provided by Federal Reserve Bank of St. Louis in its journal Review.

    Volume (Year): (2009)
    Issue (Month): Sep ()
    Pages: 519-544

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    Handle: RePEc:fip:fedlrv:y:2009:i:sep:p:519-544:n:v.91no.5,pt.2

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    Keywords: Econometric models ; Macroeconomics;

    References

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    17. Dean Croushore, 1998. "Low inflation: the surprise of the 1990s," Business Review, Federal Reserve Bank of Philadelphia, Federal Reserve Bank of Philadelphia, issue Jul, pages 3-12.
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    19. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(4), pages 745-787, May.
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    21. Jeremy Rudd & Karl Whelan, 2003. "Can rational expectations sticky-price models explain inflation dynamics?," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2003-46, Board of Governors of the Federal Reserve System (U.S.).
    22. Rudebusch, G.D., 1996. "Do Measures of Monetary Policy in a VAR Make Sense?," Papers, Banca Italia - Servizio di Studi 269, Banca Italia - Servizio di Studi.
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