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A specification analysis of discrete-time no-arbitrage term structure models with observable and unobservable factors

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  • Marcello, Pericoli
  • Marco, Taboga

Abstract

We derive a canonical representation for the no-arbitrage discrete-time term structure models with both observable and unobservable state variables, popularized by Ang and Piazzesi (2003). We conduct a specification analysis based on this canonical representation. We show that some of the restrictions commonly imposed in the literature, most notably that of independence between observable and unobservable variables, are not necessary for identification and are rejected by formal statistical tests. Furthermore, we show that there are important differences between the estimated risk premia, impulse response functions and variance decomposition of unrestricted models, parametrized according to our canonical representation, and those of models with overidentifying restrictions.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 4969.

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Date of creation: Mar 2005
Date of revision: Sep 2007
Handle: RePEc:pra:mprapa:4969

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Keywords: Term structure; canonical models;

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  1. Diebold, Francis X. & Piazzesi, Monica & Rudebusch, Glenn D., 2005. "Modeling bond yields in finance and macroeconomics," CFS Working Paper Series, Center for Financial Studies (CFS) 2005/03, Center for Financial Studies (CFS).
  2. Glenn D. Rudebusch & Brian P. Sack & Eric T. Swanson, 2006. "Macroeconomic implications of changes in the term premium," Working Paper Series, Federal Reserve Bank of San Francisco 2006-46, Federal Reserve Bank of San Francisco.
  3. Diebold, Francis X. & Rudebusch, Glenn D. & Borag[caron]an Aruoba, S., 2006. "The macroeconomy and the yield curve: a dynamic latent factor approach," Journal of Econometrics, Elsevier, Elsevier, vol. 131(1-2), pages 309-338.
  4. Fama, Eugene F., 1990. "Term-structure forecasts of interest rates, inflation and real returns," Journal of Monetary Economics, Elsevier, Elsevier, vol. 25(1), pages 59-76, January.
  5. Andrew Ang & Monika Piazzesi & Min Wei, 2003. "What does the yield curve tell us about GDP growth?," Proceedings, Federal Reserve Bank of San Francisco, Federal Reserve Bank of San Francisco, issue Mar.
  6. Gallmeyer, Michael F. & Hollifield, Burton & Zin, Stanley E., 2005. "Taylor rules, McCallum rules and the term structure of interest rates," Journal of Monetary Economics, Elsevier, Elsevier, vol. 52(5), pages 921-950, July.
  7. Frederic S. Mishkin, 1988. "What Does the Term Structure Tell Us About Future Inflation?," NBER Working Papers, National Bureau of Economic Research, Inc 2626, National Bureau of Economic Research, Inc.
  8. GlennD. Rudebusch & Tao Wu, 2008. "A Macro-Finance Model of the Term Structure, Monetary Policy and the Economy," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 118(530), pages 906-926, 07.
  9. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, Elsevier, vol. 50(4), pages 745-787, May.
  10. Andrew Ang & Sen Dong, 2005. "No-Arbitrage Taylor Rules," 2005 Meeting Papers, Society for Economic Dynamics 22, Society for Economic Dynamics.
  11. Hordahl, Peter & Tristani, Oreste & Vestin, David, 2006. "A joint econometric model of macroeconomic and term-structure dynamics," Journal of Econometrics, Elsevier, Elsevier, vol. 131(1-2), pages 405-444.
  12. Knez, Peter J & Litterman, Robert & Scheinkman, Jose Alexandre, 1994. " Explorations into Factors Explaining Money Market Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 49(5), pages 1861-82, December.
  13. Favero, Carlo A & Niu, Linlin & Sala, Luca, 2007. "Term Structure Forecasting: No-Arbitrage Restrictions vs Large Information Set," CEPR Discussion Papers, C.E.P.R. Discussion Papers 6206, C.E.P.R. Discussion Papers.
  14. Arturo Estrella & Frederic S. Mishkin, 1995. "The Term Structure of Interest Rates and Its Role in Monetary Policy for The European Central Bank," NBER Working Papers, National Bureau of Economic Research, Inc 5279, National Bureau of Economic Research, Inc.
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