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A joint econometric model of macroeconomic and term structure dynamics

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Author Info
Peter Hoerdahl
Oreste Tristani

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Abstract

We construct and estimate a joint model of macroeconomic and yield curve dynamics. A small-scale backward/forward-looking rational expectations model describes the macroeconomy. Bond yields are affine functions of the state variables of the macromodel, and are derived assuming absence of arbitrage opportunities and a flexible price of risk specification. While maintaining the tractability of the affine set-up, our approach provides a way to interpret yield dynamics in terms of macroeconomic fundamentals; time-varying risk premia, in particular, are associated with the fundamental sources of risk in the economy. In an application to German data, the model is able to capture the salient features of the term structure of interest rates and its forecasting performance matches that of the best available models based on latent factors. The model has also considerable success in accounting for the empirical failure of the expectations hypothesis.

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Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 379.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:379

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Related research
Keywords: Affine term structure models; policy rules; new neo-classical synthesis;

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Find related papers by JEL classification:
E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates
E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation

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