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An arbitrage-free three-factor term structure model and the recent behavior of long-term yields and distant-horizon forward rates

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Listed author(s):
  • Don H. Kim
  • Jonathan H. Wright

Abstract

This paper reviews a simple three-factor arbitrage-free term structure model estimated by Federal Reserve Board staff and reports results obtained from fitting this model to U.S. Treasury yields since 1990. The model ascribes a large portion of the decline in long-term yields and distant-horizon forward rates since the middle of 2004 to a fall in term premiums. A variant of the model that incorporates inflation data indicates that about two-thirds of the decline in nominal term premiums owes to a fall in real term premiums, but estimated compensation for inflation risk has diminished as well.

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File URL: http://www.federalreserve.gov/pubs/feds/2005/200533/200533abs.html
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File URL: http://www.federalreserve.gov/pubs/feds/2005/200533/200533pap.pdf
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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2005-33.

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Date of creation: 2005
Handle: RePEc:fip:fedgfe:2005-33
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Keywords: Interest rates ; Econometric models;

This paper has been announced in the following NEP Reports:

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  1. Ben S. Bernanke & Vincent R. Reinhart & Brian P. Sack, 2004. "Monetary Policy Alternatives at the Zero Bound: An Empirical Assessment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 35(2), pages 1-100.
  2. Langetieg, Terence C, 1980. " A Multivariate Model of the Term Structure," Journal of Finance, American Finance Association, vol. 35(1), pages 71-97, March.
  3. GlennD. 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, 07.
  4. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02.
  5. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, vol. 95(1), pages 138-160, March.
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