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No-Arbitrage Taylor Rules

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  • Andrew Ang
  • Sen Dong

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 GDP growth account for over half of the time-variation of yield levels and we attribute almost all of the movements in the term spread to inflation. Taylor rules estimated with no-arbitrage restrictions differ substantially from Taylor rules estimated by OLS and monetary policy shocks identified with no-arbitrage techniques are less volatile than their OLS counterparts.

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Paper provided by Society for Economic Dynamics in its series 2005 Meeting Papers with number 22.

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Date of creation: 2005
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Handle: RePEc:red:sed005:22

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Keywords: affine term structure model; monetary policy; interest rate risk;

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