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Expectations, risk premia and information spanning in dynamic term structure model estimation

  • Guimarães, Rodrigo

    ()

    (Bank of England)

This article examines the nature of the empirical instability in dynamic term structure models. I show that using survey forecasts is an effective solution because it directly addresses the information imbalance at the heart of the instability: it increases the (cross-section) information on actual dynamics, bridging the gap with the large (cross-section) information on the risk-adjusted dynamics. I relate this to other information spanning problems, particularly spanning of macro factors, and discuss the desirability of anchoring models to surveys. I also show that restricting prices of risk is not effective in ensuring stable and sensible implied expectations.

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Paper provided by Bank of England in its series Bank of England working papers with number 489.

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Length: 56 pages
Date of creation: 28 Mar 2014
Date of revision:
Handle: RePEc:boe:boeewp:0489
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  1. Easaw Joshy & Golinelli Roberto, 2010. "Households Forming Inflation Expectations: Active and Passive Absorption Rates," The B.E. Journal of Macroeconomics, De Gruyter, vol. 10(1), pages 1-32, November.
  2. Caroline JARDET & Alain MONFORT & Fulvio PEGORARO, 2011. "No-arbitrage Near-Cointegrated VAR(p) Term Structure Models, Term Premia and GDP Growth," Working Papers 2011-03, Centre de Recherche en Economie et Statistique.
  3. Ruslan Bikbov & Mikhail Chernov, 2011. "Yield Curve and Volatility: Lessons from Eurodollar Futures and Options," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 9(1), pages 66-105, Winter.
  4. Fabio Milani & Ashish Rajbhandari, 2012. "Expectation Formation and Monetary DSGE Models: Beyond the Rational Expectations Paradigm," Working Papers 111212, University of California-Irvine, Department of Economics.
  5. Heidari, Massoud & Wu, Liuren, 2009. "A Joint Framework for Consistently Pricing Interest Rates and Interest Rate Derivatives," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(03), pages 517-550, June.
  6. Kim, Don H. & Orphanides, Athanasios, 2005. "Term Structure Estimation with Survey Data on Interest Rate Forecasts," CEPR Discussion Papers 5341, C.E.P.R. Discussion Papers.
  7. Stephen Cole & Fabio Milani, 2014. "The Misspecification of Expectations in New Keynesian Models: A DSGE-VAR Approach," Working Papers 131407, University of California-Irvine, Department of Economics.
  8. Joyce, Michael & Lildholdt, Peter & Sorensen, Steffen, 2009. "Extracting inflation expectations and inflation risk premia from the term structure: a joint model of the UK nominal and real yield curves," Bank of England working papers 360, Bank of England.
  9. Smith, Tom, 2012. "Option-implied probability distributions for future inflation," Bank of England Quarterly Bulletin, Bank of England, vol. 52(3), pages 224-234.
  10. Carlo Altavilla & Raffaella Giacomini & Giuseppe Ragusa, 2013. "Anchoring the yield curve using survey expectations," CeMMAP working papers CWP52/13, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
  11. Michael D. Bauer & Glenn D. Rudebusch & Jing Cynthia Wu, 2012. "Correcting Estimation Bias in Dynamic Term Structure Models," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 30(3), pages 454-467, April.
  12. Christopher D. Carroll, 2003. "Macroeconomic Expectations of Households and Professional Forecasters," The Quarterly Journal of Economics, Oxford University Press, vol. 118(1), pages 269-298.
  13. Don H Kim & Athanasios Orphanides, 2007. "The bond market term premium: what is it, and how can we measure it?," BIS Quarterly Review, Bank for International Settlements, June.
  14. Albert Lee Chun, 2005. "Expectations, Bond Yields and Monetary Policy," Discussion Papers 04-023, Stanford Institute for Economic Policy Research, revised Nov 2010.
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