Expectations, risk premia and information spanning in dynamic term structure model estimation
AbstractThis 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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Bibliographic InfoPaper provided by Bank of England in its series Bank of England working papers with number 489.
Length: 56 pages
Date of creation: 28 Mar 2014
Date of revision:
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Interest rates; expectations; risk premium; dynamic term structure; robust; estimation;
Find related papers by JEL classification:
- C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-04-18 (All new papers)
- NEP-CFN-2014-04-18 (Corporate Finance)
- NEP-MAC-2014-04-18 (Macroeconomics)
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