The Target Rate and Term Structure of Interest Rates
AbstractThis paper presents a tractable bond valuation model, which further develops the approach proposed by Piazzesi (2005). The short term inter-bank interest rate is equal to the target rate set by the central bank plus a spread. Bond yields are driven by the intensities that determine the probabilities that the central bank may raise or cut the target interest rate. Unlike in Piazzesi (2005), negative intensities have a convenient interpretation and do not complicate estimation, and two accurate approximations to the bond pricing equation provide new closed form solutions for discount bond prices that require no numerical integration. Unlike in Piazzesi the target interest rate can be constrained to be non-negative. Yields, especially long term ones, decrease when the central bank is expected to decide more frequent and/or larger average future changes in the target interest rate. The model lends itself to easy calibration and estimation.
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Bibliographic InfoPaper provided by Department of Economics, University of York in its series Discussion Papers with number 06/15.
Date of creation: Aug 2006
Date of revision:
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Bond valuation; target interest rate; closed form solution; yield curve; central banker's meeting;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-09-11 (All new papers)
- NEP-CBA-2006-09-11 (Central Banking)
- NEP-FIN-2006-09-11 (Finance)
- NEP-FMK-2006-09-11 (Financial Markets)
- NEP-MAC-2006-09-11 (Macroeconomics)
- NEP-MON-2006-09-11 (Monetary Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Ang, Andrew & Piazzesi, Monika, 2003.
"A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables,"
Journal of Monetary Economics,
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- Qiang Dai & Kenneth Singleton, 2003. "Term Structure Dynamics in Theory and Reality," Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 631-678, July.
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