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

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  • David Bolder
  • Shudan Liu

Abstract

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.

Suggested Citation

  • David Bolder & Shudan Liu, 2007. "Examining Simple Joint Macroeconomic and Term-Structure Models: A Practitioner's Perspective," Staff Working Papers 07-49, Bank of Canada.
  • Handle: RePEc:bca:bocawp:07-49
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    References listed on IDEAS

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    1. Robert A. Jarrow, 2009. "The Term Structure of Interest Rates," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 69-96, November.
    2. Hordahl, Peter & Tristani, Oreste & Vestin, David, 2006. "A joint econometric model of macroeconomic and term-structure dynamics," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 405-444.
    3. Richard Dennis & Glenn D. Rudebusch, 2003. "Finance and macroeconomics," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue may2.
    4. Frédérick Demers, 2003. "The Canadian Phillips Curve and Regime Shifting," Staff Working Papers 03-32, Bank of Canada.
    5. Shea, Gary S, 1985. " Interest Rate Term Structure Estimation with Exponential Splines: A Note," Journal of Finance, American Finance Association, vol. 40(1), pages 319-325, March.
    6. David J. Bolder & Grahame Johnson & Adam Metzler, 2004. "An Empirical Analysis of the Canadian Term Structure of Zero-Coupon Interest Rates," Staff Working Papers 04-48, Bank of Canada.
    7. Harvey,Andrew C., 1991. "Forecasting, Structural Time Series Models and the Kalman Filter," Cambridge Books, Cambridge University Press, number 9780521405737.
    8. David Jamieson Bolder, 2001. "Affine Term-Structure Models: Theory and Implementation," Staff Working Papers 01-15, Bank of Canada.
    9. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 134-144, January.
    10. Kim, Chang-Jin, 1994. "Dynamic linear models with Markov-switching," Journal of Econometrics, Elsevier, vol. 60(1-2), pages 1-22.
    11. 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.
    12. David Jamieson Bolder & Scott Gusba, 2002. "Exponentials, Polynomials, and Fourier Series: More Yield Curve Modelling at the Bank of Canada," Staff Working Papers 02-29, Bank of Canada.
    13. Bolder, David & Streliski, David, 1999. "Yield Curve Modelling at the Bank of Canada," Technical Reports 84, Bank of Canada.
    14. Tao Wu & Glenn Rudebusch, 2003. "Macroeconomics and the Yield Curve," Computing in Economics and Finance 2003 206, Society for Computational Economics.
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    Cited by:

    1. Paul Söderlind, 2010. "Reaction of Swiss Term Premia to Monetary Policy Surprises," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 146(I), pages 385-404, March.
    2. David Jamieson Bolder & Yuliya Romanyuk, 2008. "Combining Canadian Interest-Rate Forecasts," Staff Working Papers 08-34, Bank of Canada.
    3. Nicole El Karoui & Mohamed Mrad & Caroline Hillairet, 2014. "Ramsey Rule with Progressive utility and Long Term Affine Yields Curves," Working Papers hal-00974831, HAL.
    4. David Jamieson Bolder & Simon Deeley, 2011. "The Canadian Debt-Strategy Model: An Overview of the Principal Elements," Discussion Papers 11-3, Bank of Canada.
    5. Nicole El Karoui & Mohamed Mrad & Caroline Hillairet, 2014. "Ramsey Rule with Progressive utility and Long Term Affine Yields Curves," Papers 1404.1913, arXiv.org.

    More about this item

    Keywords

    Econometric and statistical methods; Financial Markets; Interest rates;

    JEL classification:

    • C0 - Mathematical and Quantitative Methods - - General
    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • G1 - Financial Economics - - General Financial Markets

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