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Expectations, risk premia and information spanning in dynamic term structure model estimation

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  • Guimarães, Rodrigo

    ()
    (Bank of England)

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    Abstract

    This article examines the nature of the empirical instability in dynamic term structure models. I show that using survey forecasts is an effective solution because it directly addresses the information imbalance at the heart of the instability: it increases the (cross-section) information on actual dynamics, bridging the gap with the large (cross-section) information on the risk-adjusted dynamics. I relate this to other information spanning problems, particularly spanning of macro factors, and discuss the desirability of anchoring models to surveys. I also show that restricting prices of risk is not effective in ensuring stable and sensible implied expectations.

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    File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2014/wp489.pdf
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    Bibliographic Info

    Paper provided by Bank of England in its series Bank of England working papers with number 489.

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    Length: 56 pages
    Date of creation: 28 Mar 2014
    Date of revision:
    Handle: RePEc:boe:boeewp:0489

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    Related research

    Keywords: Interest rates; expectations; risk premium; dynamic term structure; robust; estimation;

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    1. Heidari, Massoud & Wu, Liuren, 2009. "A Joint Framework for Consistently Pricing Interest Rates and Interest Rate Derivatives," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(03), pages 517-550, June.
    2. Jardet, C. & Monfort, A. & Pegoraro, F., 2009. "No-arbitrage Near-Cointegrated VAR(p) Term Structure Models, Term Premia and GDP Growth," Working papers 234, Banque de France.
    3. Christopher D. Carroll, 2003. "Macroeconomic Expectations Of Households And Professional Forecasters," The Quarterly Journal of Economics, MIT Press, vol. 118(1), pages 269-298, February.
    4. Chernov, Mikhail & Mueller, Philippe, 2012. "The term structure of inflation expectations," Journal of Financial Economics, Elsevier, vol. 106(2), pages 367-394.
    5. Smith, Tom, 2012. "Option-implied probability distributions for future inflation," Bank of England Quarterly Bulletin, Bank of England, vol. 52(3), pages 224-234.
    6. Albert Lee Chun, 2005. "Expectations, Bond Yields and Monetary Policy," Discussion Papers 04-023, Stanford Institute for Economic Policy Research, revised Nov 2010.
    7. Don H. Kim & Athanasios Orphanides, 2005. "Term structure estimation with survey data on interest rate forecasts," Finance and Economics Discussion Series 2005-48, Board of Governors of the Federal Reserve System (U.S.).
    8. Altavilla, Carlo & Giacomini, Raffaella & Ragusa, Giuseppe, 2013. "Anchoring the Yield Curve Using Survey Expectations," CEPR Discussion Papers 9738, C.E.P.R. Discussion Papers.
    9. Ruslan Bikbov & Mikhail Chernov, 2011. "Yield Curve and Volatility: Lessons from Eurodollar Futures and Options," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 9(1), pages 66-105, Winter.
    10. Carlos Carvalho & Fernanda Nechio, 2012. "Do people undestand monetary policy?," Working Paper Series 2012-01, Federal Reserve Bank of San Francisco.
    11. Michael D. Bauer & Glenn D. Rudebusch & Jing Cynthia Wu, 2012. "Correcting Estimation Bias in Dynamic Term Structure Models," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 30(3), pages 454-467, April.
    12. Don H Kim & Athanasios Orphanides, 2007. "The bond market term premium: what is it, and how can we measure it?," BIS Quarterly Review, Bank for International Settlements, June.
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