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A Joint Model for the Term Structure of Interest Rates and the Macroeconomy

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  • 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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File URL: http://www.econ.kuleuven.ac.be/ew/academic/intecon/publications/wpie002.pdf
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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 wpie002.

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Length: 60 pages
Date of creation: Jun 2001
Date of revision:
Handle: RePEc:kul:kulwps:wpie002

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

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References

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  1. Hans Dewachter, 2004. "Macro factors and the term structure of interest rates," Money Macro and Finance (MMF) Research Group Conference 2003 25, Money Macro and Finance Research Group.
  2. Jin-Chuan Duan & Jean-Guy Simonato, 1995. "Estimating and Testing Exponential Affine Term Structure Models by Kalman Filter," CIRANO Working Papers 95s-44, CIRANO.
  3. Andrew Ang & Monika Piazzesi, 2001. "A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables," NBER Working Papers 8363, National Bureau of Economic Research, Inc.
  4. Kozicki, Sharon & Tinsley, P. A., 2001. "Shifting endpoints in the term structure of interest rates," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 613-652, June.
  5. Michael J. Fleming & Eli M Remolona, 1999. "The term structure of announcement effects," BIS Working Papers 71, Bank for International Settlements.
  6. Dong-Hyun Ahn & Robert F. Dittmar, 2002. "Quadratic Term Structure Models: Theory and Evidence," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 243-288, March.
  7. Marco Lyrio & Hans Dewachter & Konstantijn Maes, 2006. "A joint model for the term structure of interest rates and the macroeconomy," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(4), pages 439-462.
  8. 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.
  9. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-92, September.
  10. Hans Dewachter & Marco Lyrio & Konstantijn Maes, 2002. "The Effect of Monetary Unification on German Bond Markets," Center for Economic Studies - Discussion papers ces0205, Katholieke Universiteit Leuven, Centrum voor Economische Studiën.
  11. Kozicki, Sharon & Tinsley, P. A., 2002. "Dynamic specifications in optimizing trend-deviation macro models," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1585-1611, August.
  12. Monika Piazzesi, 2005. "Bond Yields and the Federal Reserve," Journal of Political Economy, University of Chicago Press, vol. 113(2), pages 311-344, April.
  13. Glenn Rudebusch & Tao Wu, 2004. "A macro-finance model of the term structure, monetary policy, and the economy," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  14. Vasicek, Oldrich Alfonso, 1977. "Abstract: An Equilibrium Characterization of the Term Structure," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 627-627, November.
  15. Monika Piazzesi, 2001. "An Econometric Model of the Yield Curve with Macroeconomic Jump Effects," NBER Working Papers 8246, National Bureau of Economic Research, Inc.
  16. Hans Dewachter & Marco Lyrio & Konstantijn Maes, 2001. "Estimation of a Joint Model for the Term Structure of Interest Rates and the Macroeconomy," International Economics Working Papers Series ces0118, Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics.
  17. Qiang Dai & Kenneth J. Singleton, 2000. "Specification Analysis of Affine Term Structure Models," Journal of Finance, American Finance Association, vol. 55(5), pages 1943-1978, October.
  18. Peter Hoerdahl & Oreste Tristani, 2004. "A joint econometric model of macroeconomic and term structure dynamics," Econometric Society 2004 North American Summer Meetings 379, Econometric Society.
  19. Glenn D. Rudebusch, 2001. "Term structure evidence on interest rate smoothing and monetary policy inertia," Working Paper Series 2001-02, Federal Reserve Bank of San Francisco.
  20. Knez, Peter J & Litterman, Robert & Scheinkman, Jose Alexandre, 1994. " Explorations into Factors Explaining Money Market Returns," Journal of Finance, American Finance Association, vol. 49(5), pages 1861-82, December.
  21. Berardi, Andrea, 2009. "Term Structure, Inflation, and Real Activity," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(04), pages 987-1011, August.
  22. 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.
  23. Pearson, Neil D & Sun, Tong-Sheng, 1994. " Exploiting the Conditional Density in Estimating the Term Structure: An Application to the Cox, Ingersoll, and Ross Model," Journal of Finance, American Finance Association, vol. 49(4), pages 1279-1304, September.
  24. Dai, Qiang & Singleton, Kenneth J., 2002. "Expectation puzzles, time-varying risk premia, and affine models of the term structure," Journal of Financial Economics, Elsevier, vol. 63(3), pages 415-441, March.
  25. Buraschi, Andrea & Jiltsov, Alexei, 2005. "Inflation risk premia and the expectations hypothesis," Journal of Financial Economics, Elsevier, vol. 75(2), pages 429-490, February.
  26. Vasicek, Oldrich, 1977. "An equilibrium characterization of the term structure," Journal of Financial Economics, Elsevier, vol. 5(2), pages 177-188, November.
  27. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
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