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Long‐Run Risks In The Term Structure Of Interest Rates: Estimation

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  • Taeyoung Doh

Abstract

This paper specifies and estimates a long run risks model with inflation by using the nominal term structure data in the United States from 1953 to 2006. The negative correlation between expected inflation and expected consumption growth in conjunction with the Epstein-Zin (1989) recursive preferences generates an upward sloping yield curve and fits the yield curve data better than the alternative specifications. However, the variations of the forward looking components of consumption growth and inflation in the estimated model are much smaller than implied by calibrated parameter values in the previous literature. An extended model with time varying volatilities alleviates this problem. In the extended model, estimated long run risks and volatilities, especially for inflation, are in line with survey data and the estimated inflation volatility explains a significant portion of the time variation of term premium.

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Bibliographic Info

Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 28 (2013)
Issue (Month): 3 (04)
Pages: 478-497

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Handle: RePEc:wly:japmet:v:28:y:2013:i:3:p:478-497

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  1. Giorgio Primiceri & Alejandro Justiniano, 2006. "The Time Varying Volatility of Macroeconomic Fluctuations," 2006 Meeting Papers, Society for Economic Dynamics 353, Society for Economic Dynamics.
  2. Fernández-Villaverde, Jesús & Rubio-Ramirez, Juan Francisco, 2006. "Estimating Macroeconomic Models: A Likelihood Approach," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5513, C.E.P.R. Discussion Papers.
  3. Ravi Bansal & Amir Yaron, 2004. "Risks for the Long Run: A Potential Resolution of Asset Pricing Puzzles," Journal of Finance, American Finance Association, American Finance Association, vol. 59(4), pages 1481-1509, 08.
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  5. Luca Benati, 2008. "The "Great Moderation" in the United Kingdom," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 40(1), pages 121-147, 02.
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  7. Monika Piazzesi & Martin Schneider, 2009. "Trend and cycle in bond premia," Staff Report, Federal Reserve Bank of Minneapolis 424, Federal Reserve Bank of Minneapolis.
  8. James H. Stock & Mark W. Watson, 2007. "Why Has U.S. Inflation Become Harder to Forecast?," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 39(s1), pages 3-33, 02.
  9. Jacquier, Eric & Polson, Nicholas G & Rossi, Peter E, 2002. "Bayesian Analysis of Stochastic Volatility Models," Journal of Business & Economic Statistics, American Statistical Association, American Statistical Association, vol. 20(1), pages 69-87, January.
  10. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, Econometric Society, vol. 57(4), pages 937-69, July.
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Cited by:
  1. Stefano D'Addona & Frode Brevik, 2011. "Rational Ignorance In Long-Run Risk Models," Working Papers, CREI Università degli Studi Roma Tre 0811, CREI Università degli Studi Roma Tre, revised 2011.
  2. Philippe Mueller & Andrea Vedolin & Hao Zhou, 2011. "Short Run Bond Risk Premia," FMG Discussion Papers, Financial Markets Group dp686, Financial Markets Group.
  3. Startz, Richard & Tsang, Kwok Ping, 2012. "Nonexponential Discounting: A Direct Test And Perhaps A New Puzzle," University of California at Santa Barbara, Economics Working Paper Series qt8pw4h6vk, Department of Economics, UC Santa Barbara.
  4. Anh Le & Kenneth J. Singleton, 2010. "An Equilibrium Term Structure Model with Recursive Preferences," American Economic Review, American Economic Association, American Economic Association, vol. 100(2), pages 557-61, May.

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