An affine three-factor model of the German term structure of interest rates with macroeconomic content
This paper extends the empirical no-arbitrage Gaussian affine term structure model of Cassola and Luis (2003) in a way that leads to a Taylor rule expression for the short rate dynamics. The empirical results indicate that the dynamics of the German term structure of interest rates can be sufficiently explained by expected variations in inflation and output plus an additional unobservable factor. The novelty is that we are able to extract a monetary policy reaction function within this no-arbitrage model that closely resembles empirical reaction functions based on the dynamics of the short rate only.
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Volume (Year): 1 (2005)
Issue (Month): 3 (May)
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- Nuno Cassola & Jorge Barros Luis, 2003. "A two-factor model of the German term structure of interest rates," Applied Financial Economics, Taylor & Francis Journals, vol. 13(11), pages 783-806.
- David Backus & Silverio Foresi & Chris Telmer, 1998.
"Discrete-Time Models of Bond Pricing,"
NBER Working Papers
6736, National Bureau of Economic Research, Inc.
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