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Canonical Term-Structure Models with Observable Factors and the Dynamics of Bond Risk Premia

  • MARCELLO PERICOLI
  • MARCO TABOGA

We derive a canonical representation for the no-arbitrage discrete-time term structure models with both observable and unobservable state variables, popularized by Ang and Piazzesi (2003). We conduct a specification analysis based on this canonical representation and we analyze how alternative parameterizations affect estimated risk premia, impulse response functions, and variance decompositions. We find a trade-off between the need to obtain parsimonious parameterizations and the ability of the models to match observed patterns of variation in risk premia. We also find that more richly parameterized models uncover a greater influence of macroeconomic fundamentals on the long-end of the yield curve. Copyright (c) 2008 The Ohio State University.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1538-4616.2008.00167.x
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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 40 (2008)
Issue (Month): 7 (October)
Pages: 1471-1488

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Handle: RePEc:mcb:jmoncb:v:40:y:2008:i:7:p:1471-1488
Contact details of provider: Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  1. Marianne Baxter & Robert G. King, 1995. "Measuring Business Cycles Approximate Band-Pass Filters for Economic Time Series," NBER Working Papers 5022, National Bureau of Economic Research, Inc.
  2. Andrew Ang & Monika Piazzesi & Min Wei, 2003. "What does the yield curve tell us about GDP growth?," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  3. Mishkin, F.S., 1988. "What Does The Term Structure Tell Us About Future Inflation?," Papers fb-_88-29, Columbia - Graduate School of Business.
  4. Glenn D. Rudebusch & Tao Wu, 2003. "A macro-finance model of the term structure, monetary policy, and the economy," Working Paper Series 2003-17, Federal Reserve Bank of San Francisco.
  5. Söderlind, Paul, 1998. "Solution and Estimation of RE Macromodels with Optimal Policy," SSE/EFI Working Paper Series in Economics and Finance 256, Stockholm School of Economics.
  6. Fama, Eugene F., 1990. "Term-structure forecasts of interest rates, inflation and real returns," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 59-76, January.
  7. Knez, Peter J & Litterman, Robert & Scheinkman, Jose Alexandre, 1994. " Explorations into Factors Explaining Money Market Returns," Journal of Finance, American Finance Association, vol. 49(5), pages 1861-82, December.
  8. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May.
  9. Richard Dennis & Glenn D. Rudebusch, 2003. "Finance and macroeconomics," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue may2.
  10. Arturo Estrella & Frederic S. Mishkin, 1995. "The term structure of interest rates and its role in monetary policy for the European Central Bank," Research Paper 9526, Federal Reserve Bank of New York.
  11. Charles L. Evans & David A. Marshall, 1997. "Monetary policy and the term structure of nominal interest rates: evidence and theory," Working Paper Series, Macroeconomic Issues WP-97-10, Federal Reserve Bank of Chicago.
  12. Peter Hordahl & Oreste Tristani & David Vestin, 2003. "A joint econometric model of macroeconomic and term structure," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
  13. Andrew Ang & Sen Dong & Monika Piazzesi, 2005. "No-arbitrage Taylor rules," Proceedings, Federal Reserve Bank of San Francisco.
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