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The Role of Uncertainty in the Term Structure of Interest Rates: A Macro-Finance Perspective

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  • Junko Koeda

    (Faculty of Economics, University of Tokyo)

  • Ryo Kato

    (Institute for Monetary and Economic Studies, Bank of Japan)

Abstract

Using a macroeconomic perspective, we examine the effect of uncertainty arising from policy-shock volatility on yield-curve dynamics. Many macro-finance models assume that policy shocks are homoskedastic, while observed policy shock processes are significantly time varying and persistent. We allow for this key feature by constructing a no-arbitrage GARCH affine term structure model, in which monetary policy uncertainty is modeled as the conditional volatility of the error term in a Taylor rule. We find that monetary policy uncertainty increases the medium- and longer-term spreads in a model that incorporates macroeconomic dynamics.

Suggested Citation

  • Junko Koeda & Ryo Kato, 2010. "The Role of Uncertainty in the Term Structure of Interest Rates: A Macro-Finance Perspective," CARF F-Series CARF-F-207, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  • Handle: RePEc:cfi:fseres:cf207
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    References listed on IDEAS

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