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The term structure of interest rates in a DSGE model

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  • Marina Emiris

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    (National Bank of Belgium, Research Department)

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    Abstract

    The paper evaluates the implications of the Smets and Wouters (2004) DSGE model for the US yield curve. Bond prices are modelled in a way that is consistent with the macro model and the resulting risk premium in long term bonds is a function of the macro model parameters exclusively. When the model is estimated under the restriction that the implied average 10-year term premium matches the observed premium, it turns out that risk aversion and habit only need to rise slightly, while the increase in the term premium is achieved by a drop in the monetary policy parameter that governs the aggressiveness of the monetary policy rule. A less aggressive policy increases the persistence of the reaction of inflation and the short interest rate to any shock, reinforces the covariance between the marginal rate of substitution of consumption and bond prices, turns positive the contribution of the inflation premium and drives the term premium up. The paper concludes that by generating persistent inflation the presence of nominal rigidities can help in reconciling the macro model with the yield curve data.

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    File URL: http://www.nbb.be/doc/oc/repec/reswpp/WP88.pdf
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    Bibliographic Info

    Paper provided by National Bank of Belgium in its series Working Paper Research with number 88.

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    Length: 63 pages
    Date of creation: Jul 2006
    Date of revision:
    Handle: RePEc:nbb:reswpp:200607-2

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    Keywords: term structure of interest rates; policy rules; risk premia;

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    Cited by:
    1. Bianca De Paoli & Alasdair Scott & Olaf Weeken, 2006. "Asset pricing implications of a New Keynesian model," Computing in Economics and Finance 2006 358, Society for Computational Economics.
    2. Chang, Kuang-Liang & Chen, Nan-Kuang & Leung, Charles Ka Yui, 2009. "Monetary Policy, Term Structure and Asset Return: Comparing REIT, Housing and Stock," MPRA Paper 23514, University Library of Munich, Germany.
    3. Olivier Blanchard & Jordi Gali, 2006. "A new Keynesian model with unemployment," Working Paper Research 92, National Bank of Belgium.
    4. Joachim Keller, 2008. "Agency problems in structured finance – a case study of European CLOs," Working Paper Document 137, National Bank of Belgium.
    5. Zagaglia, Paolo, 2009. "Forecasting with a DSGE Model of the term Structure of Interest Rates: The Role of the Feedback," Research Papers in Economics 2009:14, Stockholm University, Department of Economics.
    6. Joseph Plasmans & Tomasz Michalak & Jorge Fornero, 2006. "Simulation, estimation and welfare implications of monetary policies in a 3-country NOEM model," Working Paper Research 94, National Bank of Belgium.
    7. De Graeve, Ferre & Emiris, Marina & Wouters, Raf, 2009. "A structural decomposition of the US yield curve," Journal of Monetary Economics, Elsevier, vol. 56(4), pages 545-559, May.

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