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An extended macro-finance model with financial factors

Listed author(s):
  • Hans DEWACHTER
  • Leonardo IANIA

This paper extends the benchmark Macro-Finance model by introducing, next to the standard macroeconomic factors, additional liquidity-related and return forecasting factors. Liquidity factors are obtained from a decomposition of the TED spread while the return-forecasting (risk premium) factor is extracted by imposing a single factor structure on the one-period expected excess holding returns. The model is estimated on US data using MCMC techniques. Two findings stand out. First, the model outperforms significantly most structural and non-structural Macro-Finance yield curve models in terms of cross-sectional fit of the yield curve. Second, we find that financial shocks, either in the form of liquidity or risk premium shocks have a statistically and economically significant impact on the yield curve. The impact of financial shocks extends throughout the yield curve but is most pronounced at the high and intermediate frequencies.

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File URL: https://lirias.kuleuven.be/bitstream/123456789/251278/1/DPS0919.pdf
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Paper provided by KU Leuven, Faculty of Economics and Business, Department of Economics in its series Working Papers Department of Economics with number ces09.19.

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Date of creation: Nov 2009
Handle: RePEc:ete:ceswps:ces09.19
Contact details of provider: Web page: http://feb.kuleuven.be/Economics/

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