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An affine three-factor model of the German term structure of interest rates with macroeconomic content

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  • Ralf Fendel

Abstract

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.

Suggested Citation

  • Ralf Fendel, 2005. "An affine three-factor model of the German term structure of interest rates with macroeconomic content," Applied Financial Economics Letters, Taylor and Francis Journals, vol. 1(3), pages 151-156, May.
  • Handle: RePEc:taf:apfelt:v:1:y:2005:i:3:p:151-156
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    References listed on IDEAS

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    1. David K. Backus & Silverio Foresi & Chris Telmer, "undated". "Discrete time models of bond pricing," GSIA Working Papers 251, Carnegie Mellon University, Tepper School of Business.
    2. 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.
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    Cited by:

    1. Francisco Jareno, 2008. "Spanish stock market sensitivity to real interest and inflation rates: an extension of the Stone two-factor model with factors of the Fama and French three-factor model," Applied Economics, Taylor & Francis Journals, vol. 40(24), pages 3159-3171.
    2. Peter Vlaar, 2007. "Term Structure Modeling for Pension Funds:What to do in Practice?," DNB Working Papers 123, Netherlands Central Bank, Research Department.
    3. Peter Spreij & Enno Veerman & Peter Vlaar, 2008. "Multivariate Feller conditions in term structure models: Why do(n't) we care?," DNB Working Papers 173, Netherlands Central Bank, Research Department.

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