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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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Paper provided by Katholieke Universiteit Leuven, Centrum voor Economische Studiën in its series Center for Economic Studies - Discussion papers with number ces09.19.

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Date of creation: Nov 2009
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Handle: RePEc:ete:ceswps:ces09.19

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Cited by:
  1. Dewachter, Hans & Iania, Leonardo & Lyrio, Marco, 2011. "A New-Keynesian Model of the Yield Curve with Learning Dynamics: A Bayesian Evaluation," Insper Working Papers wpe_250, Insper Working Paper, Insper Instituto de Ensino e Pesquisa.
  2. Hans Dewachter & Leonardo Iania & Marco Lyrio, 2014. "Information in the yield curve: A Macro-Finance approach," Working Paper Research 254, National Bank of Belgium.
  3. Pavol Povala & Anna Cieslak, 2012. "Understanding bond risk premia," 2012 Meeting Papers 771, Society for Economic Dynamics.
  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.

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