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Demographics and The Behaviour of Interest Rates

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  • Carlo A. Favero
  • Arie E. Gozluklu
  • Haoxi Yang

Abstract

In this paper we relate the very persistent component of interest rates to a specific demographic variable, MYt, the proportion of middle-aged to young population. We first reconsider the results in Fama (2006) to document how MYt captures the long run component identified by Fama in his analysis of the one-year spot rate. Using MYt to model this low frequency component of interest rates is particularly useful for forecasting the term structure as the demographic variable is exogenous and highly predictable, even at very long horizons. We then study the forecasting performance of a no-arbitrage affine term structure model that allows for the presence of a persistent component driven by demographics. This performance is superior to that of a traditional affine term structure model with macroeconomic factors (e.g. Ang, Dong and Piazzesi, 2005).

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Bibliographic Info

Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 388.

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Date of creation: 2011
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Handle: RePEc:igi:igierp:388

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  1. Favero, Carlo A & Niu, Linlin & Sala, Luca, 2007. "Term Structure Forecasting: No-Arbitrage Restrictions vs Large Information Set," CEPR Discussion Papers 6206, C.E.P.R. Discussion Papers.
  2. Marcello Pericoli & Marco Taboga, 2008. "Canonical Term-Structure Models with Observable Factors and the Dynamics of Bond Risk Premia," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(7), pages 1471-1488, October.
  3. Amit Goyal & Ivo Welch, 2004. "A Comprehensive Look at the Empirical Performance of Equity Premium Prediction," Yale School of Management Working Papers amz2412, Yale School of Management, revised 01 Jan 2006.
  4. Peter Hordahl & Oreste Tristani & David Vestin, 2003. "A joint econometric model of macroeconomic and term structure," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  5. Geert Bekaert & Seonghoon Cho & Antonio Moreno, 2005. "New-Keynesian Macroeconomics and the Term Structure," NBER Working Papers 11340, National Bureau of Economic Research, Inc.
  6. Giacomini, Raffaella & White, Halbert, 2003. "Tests of Conditional Predictive Ability," University of California at San Diego, Economics Working Paper Series qt5jk0j5jh, Department of Economics, UC San Diego.
  7. Favero, Carlo A. & Gozluklu, Arie E. & Tamoni, Andrea, 2011. "Demographic Trends, the Dividend-Price Ratio, and the Predictability of Long-Run Stock Market Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(05), pages 1493-1520, October.
  8. Dewachter, H.D.R. & Lyrio, M., 2003. "Macro factors and the Term Structure of Interest Rates," Research Paper ERS-2003-037-F&A, Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus Uni.
  9. Gallmeyer, Michael F. & Hollifield, Burton & Zin, Stanley E., 2005. "Taylor rules, McCallum rules and the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 52(5), pages 921-950, July.
  10. Andrew Ang & Angela Maddaloni, 2003. "Do Demographic Changes Affect Risk Premiums? Evidence from International Data," NBER Working Papers 9677, National Bureau of Economic Research, Inc.
  11. Andrew Ang & Sen Dong & Monika Piazzesi, 2007. "No-Arbitrage Taylor Rules," NBER Working Papers 13448, National Bureau of Economic Research, Inc.
  12. Pierluigi Balduzzi & Sanjiv Ranjan Das & Silverio Foresi, 1997. "The Central Tendency: A Second Factor in Bond Yields," NBER Working Papers 6325, National Bureau of Economic Research, Inc.
  13. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
  14. Emanuel Mönch, 2005. "Forecasting the yield curve in a data-rich environment - a no-arbitrage factor-augmented VAR approach," Working Paper Series 544, European Central Bank.
  15. John Geanakoplos & Michael Magill & Martine Quinzii, 2004. "Demography and the Long Run Behavior of the Stock Market," Levine's Bibliography 122247000000000643, UCLA Department of Economics.
  16. Geert Bekaert & Eric Engstrom, 2009. "Inflation and the Stock Market:Understanding the "Fed Model"," NBER Working Papers 15024, National Bureau of Economic Research, Inc.
  17. Goyal, Amit, 2004. "Demographics, Stock Market Flows, and Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(01), pages 115-142, March.
  18. Ang, Andrew & Bekaert, Geert, 2002. "Regime Switches in Interest Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(2), pages 163-82, April.
  19. Francis X. Diebold & Glenn D. Rudebusch & S. Boragan Aruoba, 2004. "The Macroeconomy and the Yield Curve: A Dynamic Latent Factor Approach," NBER Working Papers 10616, National Bureau of Economic Research, Inc.
  20. Sharon Kozicki & P.A. Tinsley, 1997. "Shifting endpoints in the term structure of interest rates," Research Working Paper 97-08, Federal Reserve Bank of Kansas City.
  21. Lindh, Thomas & Malmberg, Bo, 2000. "Can age structure forecast inflation trends?," Journal of Economics and Business, Elsevier, vol. 52(1-2), pages 31-49.
  22. Stefano DellaVigna & Joshua M. Pollet, 2007. "Demographics and Industry Returns," American Economic Review, American Economic Association, vol. 97(5), pages 1667-1702, December.
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