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Challenges in macro-finance modeling

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  • Don H. Kim

Abstract

This article discusses various challenges in the specification and implementation of "macro-finance" models in which macroeconomic variables and term structure variables are modeled together in a no-arbitrage framework. The author classifies macro-finance models into pure latent-factor models ("internal basis models") and models that have observed macroeconomic variables as state variables ("external basis models") and examines the underlying assumptions behind these models. Particular attention is paid to the issue of unspanned short-run fluctuations in macroeconomic variables and their potentially adverse effect on the specification of external basis models. The author also discusses the challenge of addressing features such as structural breaks and time-varying inflation uncertainty. Empirical difficulties in the estimation and evaluation of macro-finance models are also discussed in detail.

Suggested Citation

  • Don H. Kim, 2009. "Challenges in macro-finance modeling," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 519-544.
  • Handle: RePEc:fip:fedlrv:y:2009:i:sep:p:519-544:n:v.91no.5,pt.2
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    References listed on IDEAS

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    Cited by:

    1. Dick, Christian D. & Schmeling, Maik & Schrimpf, Andreas, 2013. "Macro-expectations, aggregate uncertainty, and expected term premia," European Economic Review, Elsevier, vol. 58(C), pages 58-80.
    2. Grishchenko, Olesya V. & Vanden, Joel M. & Zhang, Jianing, 2016. "The informational content of the embedded deflation option in TIPS," Journal of Banking & Finance, Elsevier, vol. 65(C), pages 1-26.
    3. P. Byrne, Joseph & Cao, Shuo & Korobilis, Dimitris, 2015. "Term Structure Dynamics, Macro-Finance Factors and Model Uncertainty," 2007 Annual Meeting, July 29-August 1, 2007, Portland, Oregon TN 2015-71, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    4. Hernández Juan R., 2016. "Unit Root Testing in ARMA Models: A Likelihood Ratio Approach," Working Papers 2016-03, Banco de México.

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    Keywords

    Econometric models ; Macroeconomics;

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