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Term Structure Estimation with Survey Data on Interest Rate Forecasts

  • Kim, Don H.
  • Orphanides, Athanasios

The estimation of dynamic no-arbitrage term structure models with a flexible specification of the market price of risk is beset by severe small-sample problems arising from the highly persistent nature of interest rates. We propose using survey forecasts of a short-term interest rate as an additional input to the estimation to overcome the problem. To illustrate the methodology, we estimate the 3-factor affine-Gaussian model with U.S. Treasury yields data and demonstrate that incorporating information from survey forecasts mitigates the small-sample problem. The model thus estimated for the 1990–2003 sample generates a stable and sensible estimate of the expected path of the short rate, reproduces the well-known stylized patterns in the expectations hypothesis tests, and captures some of the short-run variations in the survey forecast of the changes in longer-term interest rates.

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Article provided by Cambridge University Press in its journal Journal of Financial and Quantitative Analysis.

Volume (Year): 47 (2012)
Issue (Month): 01 (April)
Pages: 241-272

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Handle: RePEc:cup:jfinqa:v:47:y:2012:i:01:p:241-272_00
Contact details of provider: Postal: Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK
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