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

  • Guimarães, Rodrigo

    ()

    (Bank of England)

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    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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    File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2014/wp489.pdf
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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. Altavilla, Carlo & Giacomini, Raffaella & Ragusa, Giuseppe, 2013. "Anchoring the Yield Curve Using Survey Expectations," CEPR Discussion Papers 9738, C.E.P.R. Discussion Papers.
    2. Kim, Don H. & Orphanides, Athanasios, 2012. "Term Structure Estimation with Survey Data on Interest Rate Forecasts," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 47(01), pages 241-272, April.
    3. 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.
    4. 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.
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    7. Fernanda Nechio & Carlos Carvalho, 2012. "Do People Understand Monetary Policy?," 2012 Meeting Papers 426, Society for Economic Dynamics.
    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. Christopher D Carroll, 2002. "Macroeconomic Expectations of Households and Professional Forecasters," Economics Working Paper Archive 477, The Johns Hopkins University,Department of Economics.
    10. 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.
    11. 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.
    12. Albert Lee Chun, 2005. "Expectations, Bond Yields and Monetary Policy," Discussion Papers 04-023, Stanford Institute for Economic Policy Research, revised Nov 2010.
    13. Smith, Tom, 2012. "Option-implied probability distributions for future inflation," Bank of England Quarterly Bulletin, Bank of England, vol. 52(3), pages 224-234.
    14. 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.
    15. 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.
    16. 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.
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