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Does Macroeconomics Help Us To Understand the Term Structure of Interest Rates?

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  • Favero, Carlo A

Abstract

The expectations model of the term structure states that the yields to maturity of long-term bonds are equal to the average of expected future short-term bond yields. This venerable model has been subjected to numerous empirical tests and almost invariably rejected. The empirical failure is generally attributed either to systematic expectations errors, or to shifts in the risk premia. In fact, the empirical tests, based on the estimation of single-equation models, are not able to discriminate between these two hypotheses. A recent strand of the macro-economic literature has analysed monetary policy by including the central bank reaction function is small empirical macro models. By simulating these models forward it is possible to derive the full forward path of short-term interest rates and hence to construct any long-term interest rate consistent with the expectations model. A direct test of the theory, based on full information, can then be immediately constructed by comparing observed long-term rates with the simulated ones and the associated 95% confidence interval. This is what we do in this Paper. Our results shed new light on the empirical validity of the expectations model.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2849.

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Date of creation: Jun 2001
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Handle: RePEc:cpr:ceprdp:2849

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Keywords: expectations model; small macro-models; term structure of interest rates;

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Cited by:
  1. Zeno Rotondi & Giacomo Vaciago, 2007. "Lessons from the ECB experience: Frankfurt still matters!," DISCE - Quaderni dell'Istituto di Economia e Finanza ief0070, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
  2. Tuysuz, Sukriye, 2007. "The asymmetric impact of macroeconomic announcements on U.S. Government bond rate level and volatility," MPRA Paper 5381, University Library of Munich, Germany.
  3. Zeno Rotondi & Giacomo Vaciago, 2003. "The reputation of a newborn central bank," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 56(224), pages 3-22.
  4. Modena, Matteo, 2008. "Yield curve, time varying term premia, and business cycle fluctuations," MPRA Paper 8873, University Library of Munich, Germany.
  5. Tuysuz, Sukriye, 2007. "The effects of a greater central bank credibility on interest rates level and volatility response to news in the U.K," MPRA Paper 5263, University Library of Munich, Germany.

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