Challenges in macro-finance modeling
AbstractThis paper 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. I classify macro-finance models into pure latent-factor models ("internal basis models") and models which have observed macroeconomic variables as state variables ("external basis models"), and examine the underlying assumptions behind these models. Particular attention is paid to the issue of unspanned short-run fluctuations in macro variables and their potentially adverse effect on the specification of external basis models. I also discuss the challenge of addressing features like 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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Bibliographic InfoPaper provided by Bank for International Settlements in its series BIS Working Papers with number 240.
Length: 44 pages
Date of creation: Dec 2007
Date of revision:
Term structure of interest rates; inflation expectations; macro-finance modeling; no-arbitrage models;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-12-19 (All new papers)
- NEP-CBA-2007-12-19 (Central Banking)
- NEP-MAC-2007-12-19 (Macroeconomics)
- NEP-MON-2007-12-19 (Monetary Economics)
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