Through explicitly incorporating analysts' forecasts as observable factors in a dynamic arbitrage- free model of the yield curve, this paper proposes a framework for studying the impact of shifts in market sentiment on interest rates of all maturities. An empirical examination reveals that survey expectations about in°ation, output growth and the anticipated path of monetary policy actions contain important information for explaining movements in bond yields. Although perceptions about in°ation are largely responsible for movements in long-term interest rates, an explicit slope factor is necessary to adequately capture the dynamics of the yield curve. Macroeconomic forecasts play an important role in explaining time-variation in the market prices of risk, with forecasted GDP growth playing a dominant role. The estimated coe±cients from a forward-looking monetary policy rule support the assertion that the central bank preemptively reacts to in°ationary expectations while suggesting patience in accommodating real output growth expectations. Models of this type may provide traders and policymakers with a new set of tools for formally assessing the reaction of bond yields to shifts in market expectations due to the arrival of news or central bank statements and announcements.
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Paper provided by EconWPA in its series Finance with number
0512006.
Find related papers by JEL classification: E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Determination of Interest Rates; Term Structure of Interest Rates E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy G12 - Financial Economics - - General Financial Markets - - - Asset Pricing D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
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