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Canonical Term-Structure Models with Observable Factors and the Dynamics of Bond Risk Premia

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  • MARCELLO PERICOLI
  • MARCO TABOGA

Abstract

We derive a canonical representation for the no-arbitrage discrete-time term structure models with both observable and unobservable state variables, popularized by Ang and Piazzesi (2003). We conduct a specification analysis based on this canonical representation and we analyze how alternative parameterizations affect estimated risk premia, impulse response functions, and variance decompositions. We find a trade-off between the need to obtain parsimonious parameterizations and the ability of the models to match observed patterns of variation in risk premia. We also find that more richly parameterized models uncover a greater influence of macroeconomic fundamentals on the long-end of the yield curve. Copyright (c) 2008 The Ohio State University.

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Bibliographic Info

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

Volume (Year): 40 (2008)
Issue (Month): 7 (October)
Pages: 1471-1488

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Handle: RePEc:mcb:jmoncb:v:40:y:2008:i:7:p:1471-1488

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

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  1. Mishkin, Frederic S., 1990. "What does the term structure tell us about future inflation?," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 77-95, January.
  2. Richard Dennis & Glenn D. Rudebusch, 2003. "Finance and macroeconomics," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue may2.
  3. Peter Hordahl & Oreste Tristani & David Vestin, 2003. "A joint econometric model of macroeconomic and term structure," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  4. Tao Wu & Glenn Rudebusch, 2004. "A Macro-Finance Model of the Term Structure, Monetary Policy, and the Economy," 2004 Meeting Papers 104, Society for Economic Dynamics.
  5. Fama, Eugene F., 1990. "Term-structure forecasts of interest rates, inflation and real returns," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 59-76, January.
  6. Andrew Ang & Sen Dong & Monika Piazzesi, 2005. "No-arbitrage Taylor rules," Proceedings, Federal Reserve Bank of San Francisco.
  7. Charles L. Evans & David A. Marshall, 1997. "Monetary policy and the term structure of nominal interest rates: evidence and theory," Working Paper Series, Macroeconomic Issues WP-97-10, Federal Reserve Bank of Chicago.
  8. Andrew Ang & Monika Piazzesi & Min Wei, 2003. "What does the yield curve tell us about GDP growth?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  9. Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
  10. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
  11. Marianne Baxter & Robert G. King, 1995. "Measuring Business Cycles Approximate Band-Pass Filters for Economic Time Series," NBER Working Papers 5022, National Bureau of Economic Research, Inc.
  12. Arturo Estrella & Frederic S. Mishkin, 1995. "The term structure of interest rates and its role in monetary policy for the European Central Bank," Research Paper 9526, Federal Reserve Bank of New York.
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Cited by:
  1. Hamilton, James D. & Wu, Jing Cynthia, 2014. "Testable implications of affine term structure models," Journal of Econometrics, Elsevier, vol. 178(P2), pages 231-242.
  2. Taboga, Marco, 2009. "Macro-finance VARs and bond risk premia: A caveat," Review of Financial Economics, Elsevier, vol. 18(4), pages 163-171, October.
  3. James D. Hamilton & Jing Cynthia Wu, 2012. "Identification and Estimation of Gaussian Affine Term Structure Models," NBER Working Papers 17772, National Bureau of Economic Research, Inc.
  4. Pericoli, Marcello & Taboga, Marco, 2012. "Bond risk premia, macroeconomic fundamentals and the exchange rate," International Review of Economics & Finance, Elsevier, vol. 22(1), pages 42-65.
  5. Carlo A. Favero & Arie E. Gozluklu & Haoxi Yang, 2011. "Demographics and The Behaviour of Interest Rates," Working Papers 388, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  6. Marcello Pericoli, 2013. "Macroeconomic and monetary policy surprises and the term structure of interest rates," Temi di discussione (Economic working papers) 927, Bank of Italy, Economic Research and International Relations Area.
  7. Carlo A. Favero & Linlin Niu & Luca Sala, 2012. "Term Structure Forecasting: No‐Arbitrage Restrictions versus Large Information Set," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 31(2), pages 124-156, 03.
  8. Joslin, Scott & Le, Anh & Singleton, Kenneth J., 2013. "Why Gaussian macro-finance term structure models are (nearly) unconstrained factor-VARs," Journal of Financial Economics, Elsevier, vol. 109(3), pages 604-622.
  9. repec:wyi:wpaper:002005 is not listed on IDEAS
  10. Giuseppe Ferrero & Andrea Nobili, 2008. "Short-term interest rate futures as monetary policy forecasts," Temi di discussione (Economic working papers) 681, Bank of Italy, Economic Research and International Relations Area.
  11. Felix Geiger, 2009. "International Interest-Rate Risk Premia in Affine Term Structure Models," Diskussionspapiere aus dem Institut für Volkswirtschaftslehre der Universität Hohenheim 316/2009, Department of Economics, University of Hohenheim, Germany.
  12. Marco S. Matsumura, 2006. "Impact of Macro Shocks on Sovereign Default Probabilities," Discussion Papers 1241, Instituto de Pesquisa Econômica Aplicada - IPEA.
  13. repec:wyi:journl:002125 is not listed on IDEAS
  14. Taboga, Marco, 2007. "Structural change and the bond yield conundrum," MPRA Paper 4965, University Library of Munich, Germany.
  15. Ferrero, Giuseppe & Nobili, Andrea, 2008. "Futures contract rates as monetary policy forecasts," Working Paper Series 0979, European Central Bank.
  16. Paolo Angelini & Sergio Nicoletti-Altimari & Ignazio Visco, 2012. "Macroprudential, microprudential and monetary policies: conflicts, complementarities and trade-offs," Questioni di Economia e Finanza (Occasional Papers) 140, Bank of Italy, Economic Research and International Relations Area.
  17. Marcello Pericoli, 2012. "Expected inflation and inflation risk premium in the euro area and in the United States," Temi di discussione (Economic working papers) 842, Bank of Italy, Economic Research and International Relations Area.

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