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An Equilibrium Model of Nominal Bond Prices with Inflation-Output Correlation and Stochastic Volatility

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  • Boudoukh, Jacob
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    Abstract

    A vector autoregressive (VAR) model is used to describe the joint dynamics of consumption growth and inflation. The commonly used homoscedastic VAR is extended to allow for stochastic volatility, driven by an unobservable autoregressive factor. Bond prices, the conditional expectation of a function of these factors, are approximated using Tauchen's quadrature method. We show that the mean, variance, and autocorrelation of yields is captured relatively well by the VAR-SV model, calibrated with inflation and consumption data. The co-dependents of consumption and inflation are shown to be important determinants for both real and nominal rates. Time variations in inflation volatility generate realistic variability of risk premia, but unrealistically low average magnitudes. Copyright 1993 by Ohio State University Press.

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    Bibliographic Info

    Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

    Volume (Year): 25 (1993)
    Issue (Month): 3 (August)
    Pages: 636-65

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    Handle: RePEc:mcb:jmoncb:v:25:y:1993:i:3:p:636-65

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    Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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    Cited by:
    1. Andrew Ang & Geert Bekaert & Min Wei, 2007. "The Term Structure of Real Rates and Expected Inflation," NBER Working Papers 12930, National Bureau of Economic Research, Inc.
    2. Hasseltoft, Henrik, 2007. "The Long-run Risk Model: Dynamics and Cyclicality of Interest Rates," SIFR Research Report Series 58, Institute for Financial Research.
    3. Michael W. Brandt & Amir Yaron, 2003. "Time-Consistent No-Arbitrage Models of the Term Structure," NBER Working Papers 9458, National Bureau of Economic Research, Inc.
    4. Monika Piazzesi & Martin Schneider, 2007. "Equilibrium Yield Curves," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 389-472 National Bureau of Economic Research, Inc.
    5. Joshua Rosenberg, 1999. "Empirical Tests of Interest Rate Model Pricing Kernels," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-015, New York University, Leonard N. Stern School of Business-.

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