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Demographics and The Behaviour of Interest Rates

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  • Carlo A. Favero
  • Arie E. Gozluklu
  • Haoxi Yang

Abstract

In this paper we relate the very persistent component of interest rates to a specific demographic variable, MYt, the proportion of middle-aged to young population. We first reconsider the results in Fama (2006) to document how MYt captures the long run component identified by Fama in his analysis of the one-year spot rate. Using MYt to model this low frequency component of interest rates is particularly useful for forecasting the term structure as the demographic variable is exogenous and highly predictable, even at very long horizons. We then study the forecasting performance of a no-arbitrage affine term structure model that allows for the presence of a persistent component driven by demographics. This performance is superior to that of a traditional affine term structure model with macroeconomic factors (e.g. Ang, Dong and Piazzesi, 2005).

Suggested Citation

  • Carlo A. Favero & Arie E. Gozluklu & Haoxi Yang, 2011. "Demographics and The Behaviour of Interest Rates," Working Papers 388, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  • Handle: RePEc:igi:igierp:388
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    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • J11 - Labor and Demographic Economics - - Demographic Economics - - - Demographic Trends, Macroeconomic Effects, and Forecasts

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