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A New Approach to Estimating Portfolio-Balance Models of the Yield Curve

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  • Antonio Diez de los Rios

Abstract

We show that the parameters of a broad class of portfolio-balance models can be recovered from estimates of Gaussian dynamic term structure models (GDTSMs) using a two-step estimator that bypasses the fixed-point problem that characterizes portfolio balance models. Specifically, we develop a novel canonical representation of bond supply in terms of factor-mimicking portfolios, whose returns replicate the structural shocks to the pricing factors. We identify these structural shocks by assuming that each shock corresponds to a distinct, mutually exclusive dimension of bond-supply variation. Using U.S. Treasury yields and macroeconomic data, we show the recovered shocks admit interpretations as hedging-risk-premium, risk-bearing-capacity, and monetary policy shocks.

Suggested Citation

  • Antonio Diez de los Rios, 2026. "A New Approach to Estimating Portfolio-Balance Models of the Yield Curve," Staff Working Papers 26-33, Bank of Canada.
    • Handle: RePEc:bca:bocawp:26-33
    DOI: 10.34989/swp-2026-33
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    JEL classification:

    • E - Macroeconomics and Monetary Economics
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G - Financial Economics
    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H - Public Economics
    • H6 - Public Economics - - National Budget, Deficit, and Debt
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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