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An Extended Macro-Finance Model with Financial Factors

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  • Hans Dewachter
  • Leonardo Iania

Abstract

This paper extends the benchmark Macro-Finance model by introducing, next to the standard macroeconomic factors, additional liquidity-related and return forecasting factors. Liquidity factors are obtained from a decomposition of the TED spread while the return-forecasting (risk premium) factor is extracted by imposing a single factor structure on the one-period expected excess holding returns. The model is estimated on US data using MCMC techniques. Two findings stand out. First, the model outperforms significantly most structural and non-structural Macro-Finance yield curve models in terms of cross-sectional fit of the yield curve. Second, we find that financial shocks, either in the form of liquidity or risk premium shocks, have a statistically and economically significant impact on the yield curve. The impact of financial shocks extends throughout the yield curve but is most pronounced at the high and intermediate frequencies.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2950.

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Date of creation: 2010
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Handle: RePEc:ces:ceswps:_2950

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Keywords: yield curve; affine models; macroeconomics and financial factors; Bayesian estimation;

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References

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Cited by:
  1. Dewachter, Hans & Iania, Leonardo & Lyrio, Marco, 2011. "Information in the Yield Curve: A Macro-Finance Approach," Insper Working Papers, Insper Working Paper, Insper Instituto de Ensino e Pesquisa wpe_230, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
  2. Dewachter, Hans & Iania, Leonardo & Lyrio, Marco, 2011. "A New-Keynesian model of the yield curve with learning dynamics: A Bayesian evaluation," MPRA Paper 34461, University Library of Munich, Germany, revised Sep 2011.
  3. Peter Spencer, 2013. "The US Economy, the Treasury Bond Market and the Specification of Macro-Finance Models," Discussion Papers 13/22, Department of Economics, University of York.
  4. Chadha, Jagjit S. & Waters, Alex, 2014. "Applying a macro-finance yield curve to UK quantitative Easing," Journal of Banking & Finance, Elsevier, vol. 39(C), pages 68-86.
  5. Pavol Povala & Anna Cieslak, 2012. "Understanding bond risk premia," 2012 Meeting Papers, Society for Economic Dynamics 771, Society for Economic Dynamics.

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