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No-Arbitrage Taylor Rules

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  • Andrew Ang
  • Sen Dong
  • Monika Piazzesi

Abstract

We estimate Taylor (1993) rules and identify monetary policy shocks using no-arbitrage pricing techniques. Long-term interest rates are risk-adjusted expected values of future short rates and thus provide strong over-identifying restrictions about the policy rule used by the Federal Reserve. The no-arbitrage framework also accommodates backward-looking and forward-looking Taylor rules. We find that inflation and output gap account for over half of the variation of time-varying excess bond returns and most of the movements in the term spread. Taylor rules estimated with no-arbitrage restrictions differ from Taylor rules estimated by OLS, and the resulting monetary policy shocks are somewhat less volatile than their OLS counterparts.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13448.

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Date of creation: Sep 2007
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Publication status: published as Andrew Ang & Sen Dong & Monika Piazzesi, 2005. "No-arbitrage Taylor rules," Proceedings, Federal Reserve Bank of San Francisco.
Handle: RePEc:nbr:nberwo:13448

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