Imperfect information, macroeconomic dynamics and the yield curve : an encompassing macro-finance model
AbstractIn this paper we estimate an encompassing Macro-Finance model allowing for time variation in the equilibrium real rate, mispricing and learning dynamics. The encompassing model specification incorporates (i) a small-scale (semi-) structural New-Keynesian model, (ii) flexible price of risk specifications, (iii) liquidity premiums in the form of (constant) deviations from (Gaussian) no-arbitrage and (iv) learning dynamics. This model is estimated on US data using MCMC techniques. We find that the encompassing model outperforms significantly standard Macro-Finance models in terms of marginal likelihood and BIC. Three findings stand out. First, unlike standard Macro-Finance models, a substantial fraction of the variation in long-term yields is attributed to changes in the perceived equilibrium real rate. Second, statistically and economically significant learning effects, especially for inflation expectations, are found. Finally, historical decompositions show that the model can replicate the US yield curve dynamics over the period 1960-2007.
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Bibliographic InfoPaper provided by National Bank of Belgium in its series Working Paper Research with number 144.
Length: 71 pages
Date of creation: Oct 2008
Date of revision:
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Imperfect information; New-Keynesian macroeconomic dynamics; equilibrium real rate; affine yield curve models;
Find related papers by JEL classification:
- E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-11-11 (All new papers)
- NEP-CBA-2008-11-11 (Central Banking)
- NEP-MAC-2008-11-11 (Macroeconomics)
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