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Modeling Yields at the Zero Lower Bound: Are Shadow Rates the Solution?

In: Dynamic Factor Models

Author

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  • Jens H. E. Christensen
  • Glenn D. Rudebusch

Abstract

Recent U.S. Treasury yields have been constrained to some extent by the zero lower bound (ZLB) on nominal interest rates. Therefore, we compare the performance of a standard affine Gaussian dynamic term structure model (DTSM), which ignores the ZLB, to a shadow-rate DTSM, which respects the ZLB. Near the ZLB, we find notable declines in the forecast accuracy of the standard model, while the shadow-rate model forecasts well. However, 10-year yield term premiums are broadly similar across the two models. Finally, in applying the shadow-rate model, we find no gain from estimating a slightly positive lower bound on U.S. yields.

Suggested Citation

  • Jens H. E. Christensen & Glenn D. Rudebusch, 2016. "Modeling Yields at the Zero Lower Bound: Are Shadow Rates the Solution?," Advances in Econometrics, in: Dynamic Factor Models, volume 35, pages 75-125, Emerald Group Publishing Limited.
    • Handle: RePEc:eme:aecozz:s0731-905320150000035003
    DOI: 10.1108/S0731-905320150000035003
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    Keywords

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    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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