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Examining Simple Joint Macroeconomic and Term-Structure Models: A Practitioner's Perspective

  • David Bolder
  • Shudan Liu

The primary objective of this paper is to compare a variety of joint models of the term structure of interest rates and the macroeconomy. To this end, we consider six alternative approaches. Three of these models follow from the work of Diebold and Li (2003) with a generalization in Bolder (2006). The fourth model is a regression-based approach motivated entirely by empirical considerations. The fifth model follows from the seminal work of Ang and Piazzesi (2003), who suggest a joint macro-finance model in a discrete-time affine setting. The final model, which we term an observed-affine model, represents an adjustment to the Ang-Piazzesi model that essentially relaxes restrictions on the state-variable dynamics by making them observable. The observed-affine model is similar in spirit to work by Colin-Dufresne, Goldstein, and Jones (2005) and Cochrane and Piazzesi (2006). Using monthly Canadian data from 1973 to 2005, we compare each of these models in terms of their out-of-sample ability to forecast the transition density of zero-coupon rates. We also examine a simple approach aimed at permitting a subset of the parameters in the non-affine models to vary over time. We find, similar to Bolder (2006), that the Diebold and Li (2003) motivated approaches provide the most appealing modelling alternative across our different comparison criteria.

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Paper provided by Bank of Canada in its series Working Papers with number 07-49.

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Length: 79 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:bca:bocawp:07-49
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  1. repec:cup:cbooks:9780521321969 is not listed on IDEAS
  2. Kim, Chang-Jin, 1994. "Dynamic linear models with Markov-switching," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 1-22.
  3. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 134-44, January.
  4. David Jamieson Bolder, 2001. "Affine Term-Structure Models: Theory and Implementation," Working Papers 01-15, Bank of Canada.
  5. Robert A. Jarrow, 2009. "The Term Structure of Interest Rates," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 69-96, November.
  6. Bolder, David & Streliski, David, 1999. "Yield Curve Modelling at the Bank of Canada," Technical Reports 84, Bank of Canada.
  7. Hördahl, Peter & Tristani, Oreste & Vestin, David, 2004. "A joint econometric model of macroeconomic and term structure dynamics," Working Paper Series 0405, European Central Bank.
  8. Richard Dennis & Glenn D. Rudebusch, 2003. "Finance and macroeconomics," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue may2.
  9. L. C. G. Rogers, 1997. "The Potential Approach to the Term Structure of Interest Rates and Foreign Exchange Rates," Mathematical Finance, Wiley Blackwell, vol. 7(2), pages 157-176.
  10. David J. Bolder & Grahame Johnson & Adam Metzler, 2004. "An Empirical Analysis of the Canadian Term Structure of Zero-Coupon Interest Rates," Working Papers 04-48, Bank of Canada.
  11. repec:cup:cbooks:9780521405737 is not listed on IDEAS
  12. Shea, Gary S, 1985. " Interest Rate Term Structure Estimation with Exponential Splines: A Note," Journal of Finance, American Finance Association, vol. 40(1), pages 319-25, March.
  13. Tao Wu & Glenn Rudebusch, 2003. "Macroeconomics and the Yield Curve," Computing in Economics and Finance 2003 206, Society for Computational Economics.
  14. Frédérick Demers, 2003. "The Canadian Phillips Curve and Regime Shifting," Working Papers 03-32, Bank of Canada.
  15. David Jamieson Bolder & Scott Gusba, 2002. "Exponentials, Polynomials, and Fourier Series: More Yield Curve Modelling at the Bank of Canada," Working Papers 02-29, Bank of Canada.
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