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Estimating Term Structure Equations Using Macroeconomic Variables

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Abstract

This paper begins with the expectations theory of the term structure of interest rates with constant term premia and then postulates how expectations of future short term interest rates are formed. Expectations depend in part on predictions from a set of VAR equations and in part on the current and two lagged values of the short term interest rate. The results suggest that there is relevant independent information in both the VAR equations' predictions and the current and two lagged values of the short rate. The model fits the long term interest rate data well, including the 2004-2006 period, which some have found a puzzle. The properties of the model are consistent with the response of the long term U.S. Treasury bond rate to surprise price and employment announcements. The overall results suggest that long term rates can be fairly well explained by modeling expectation formation of future short term rates.

Suggested Citation

  • Ray C. Fair, 2008. "Estimating Term Structure Equations Using Macroeconomic Variables," Cowles Foundation Discussion Papers 1634, Cowles Foundation for Research in Economics, Yale University.
    • Handle: RePEc:cwl:cwldpp:1634
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    References listed on IDEAS

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    1. Glenn D. Rudebusch & Tao Wu, 2008. "A Macro‐Finance Model of the Term Structure, Monetary Policy and the Economy," Economic Journal, Royal Economic Society, vol. 118(530), pages 906-926, July.
    2. Glenn D. Rudebusch & Brian P. Sack & Eric T. Swanson, 2007. "Macroeconomic implications of changes in the term premium," Review, Federal Reserve Bank of St. Louis, vol. 89(Jul), pages 241-270.
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    Cited by:

    1. Elizondo Rocío, 2023. "The Three Intelligible Factors of the Yield Curve in Mexico," Working Papers 2023-13, Banco de México.

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    More about this item

    Keywords

    Term structure equations; Expectations theory;

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects

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