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Estimation of a Joint Model for the Term Structure of Interest Rates and the Macroeconomy

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Author Info

  • Hans Dewachter

    ()
    (K.U.Leuven and Erasmus University of Rotterdam)

  • Marco Lyrio

    ()
    (K.U.Leuven, C.E.S., International Economics)

  • Konstantijn Maes

    ()
    (K.U.Leuven, C.E.S., International Economics)

Abstract

In this paper, we present a stylized continuous time model integrating the macroeconomy and the bond markets. We use this framework to estimate (real) interest rate policy rules using information contained in both macroeconomic variables (i.e. output and inflation) and in the term structure of interest rates. We extend the standard Kalman filter procedure in order to estimate this model efficiently. Application to the U.S. economy shows that this model is able to estimate the macroeconomic dynamics accurately and that the standard feedback rule only in observable factors is not valid within this framework. Moreover, we find that observable macroeconomic variables do not explain much of the term structure. However, (filtered) stochastic central tendencies of these macroeconomic variables do. Finally, both observable and non-observable factors determine the risk premia and hence the excess holding returns of the bonds.

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Bibliographic Info

Paper provided by Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics in its series International Economics Working Papers Series with number ces0118.

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Length: 60 pages
Date of creation: Jun 2001
Date of revision:
Handle: RePEc:kul:kulwps:ces0118

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Related research

Keywords: essentially affine term structure model; feedback interest rate rule; forecasting;

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Cited by:
  1. Hans Dewachter & Marco Lyrio & Konstantijn Maes, 2006. "A multi-factor model for the valuation and risk managment of demand deposits," Working Paper Research 83, National Bank of Belgium.
  2. Marco Lyrio & Hans Dewachter, 2004. "Filtering Long-Run Inflation Expectations with a Structural Macro Model of the Yield Curve," Computing in Economics and Finance 2004 188, Society for Computational Economics.
  3. Dewachter, Hans & Lyrio, Marco, 2006. "Macro Factors and the Term Structure of Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(1), pages 119-140, February.
  4. Hiona Balfoussia & Mike Wickens, 2007. "Macroeconomic Sources of Risk in the Term Structure," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(1), pages 205-236, 02.
  5. Duffee, Gregory R., 2006. "Term structure estimation without using latent factors," Journal of Financial Economics, Elsevier, vol. 79(3), pages 507-536, March.
  6. Hans Dewachter & Marco Lyrio & Konstantijn Maes, 2001. "A Joint Model for the Term Structure of Interest Rates and the Macroeconomy," International Economics Working Papers Series wpie002, Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics.
  7. Konstantijn Maes, 2004. "Modeling the Term Structure of Interest Rates: Where Do We Stand?," Working Paper Research 42, National Bank of Belgium.

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