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Macro Factors and the Term Structure of Interest Rates

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  • Hans Dewachter

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

  • Marco Lyrio

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

Abstract

This paper presents an essentially affine model of the term structure of interest rates making use of macroeconomic factors and their long-run expectations. The model extends the approach pioneered by Kozicki and Tinsley (2001) by modelling consistently long-run inflation expectations simultaneously with the term structure. This model thus avoids the standard pre-filtering of long-run expectations, as proposed by Kozicki and Tinsley (2001). Application to the U.S. economy shows the importance of long-run inflation expectations in the modelling of long-term bonds. The paper also provides a macroeconomic interpretation for the factors found in a latent factor model of the term structure. More specifically, we find that the standard "level" factor is highly correlated to long-run inflation expectations, the "slope" factor captures temporary business cycle conditions, while the "curvature" factor represents a clear independent monetary policy factor.

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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 wpie007.

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Length: 41 pages
Date of creation: Oct 2002
Date of revision:
Handle: RePEc:kul:kulwps:wpie007

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Keywords: essentially affine term structure model; macroeconomic factors; long-run market expectations; monetary policy rule;

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References

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  1. 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.
  2. 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.
  3. 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.
  4. Mishkin, F.S., 1988. "What Does The Term Structure Tell Us About Future Inflation?," Papers fb-_88-29, Columbia - Graduate School of Business.
  5. 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.
  6. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
  7. Richard Clarida & Jordi Gali & Mark Gertler, 1998. "Monetary policy rules in practice," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  8. Perron, P. & Bai, J., 1995. "Estimating and Testing Linear Models with Multiple Structural Changes," Cahiers de recherche 9552, Universite de Montreal, Departement de sciences economiques.
  9. Rudebusch, Glenn D., 2002. "Term structure evidence on interest rate smoothing and monetary policy inertia," Journal of Monetary Economics, Elsevier, vol. 49(6), pages 1161-1187, September.
  10. Bakshi, Gurdip S & Chen, Zhiwu, 1996. "Inflation, Asset Prices, and the Term Structure of Interest Rates in Monetary Economies," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 241-75.
  11. 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.
  12. Qiang Dai & Kenneth J. Singleton, 1997. "Specification Analysis of Affine Term Structure Models," NBER Working Papers 6128, National Bureau of Economic Research, Inc.
  13. Richard Clarida & Jordi Gali & Mark Gertler, 1997. "Monetary Policy Rules in Practice: Some International Evidence," NBER Working Papers 6254, National Bureau of Economic Research, Inc.
  14. Michael J. Fleming & Eli M. Remolona, 1999. "The term structure of announcement effects," Staff Reports 76, Federal Reserve Bank of New York.
  15. 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.
  16. 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.
  17. Charles L. Evans & David A. Marshall, 1997. "Monetary policy and the term structure of nominal interest rates: evidence and theory," Working Paper Series, Macroeconomic Issues WP-97-10, Federal Reserve Bank of Chicago.
  18. de Jong, Frank, 1999. "Time-series and Cross-section Information in Affine Term Structure Models," CEPR Discussion Papers 2065, C.E.P.R. Discussion Papers.
  19. 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.
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