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Estimation of a Joint Model for the Term Structure of Interest Rates and the Macroeconomy

Author

Listed:
  • Hans Dewachter

    () (K.U.Leuven and Erasmus University of Rotterdam)

  • Marco Lyrio

    () (K.U.Leuven, C.E.S., International Economics)

  • Konstantijn Maes

    () (K.U.Leuven, C.E.S., International Economics)

Abstract

In this paper, we present a stylized continuous time model integrating the macroeconomy and the bond markets. We use this framework to estimate (real) interest rate policy rules using information contained in both macroeconomic variables (i.e. output and inflation) and in the term structure of interest rates. We extend the standard Kalman filter procedure in order to estimate this model efficiently. Application to the U.S. economy shows that this model is able to estimate the macroeconomic dynamics accurately and that the standard feedback rule only in observable factors is not valid within this framework. Moreover, we find that observable macroeconomic variables do not explain much of the term structure. However, (filtered) stochastic central tendencies of these macroeconomic variables do. Finally, both observable and non-observable factors determine the risk premia and hence the excess holding returns of the bonds.

Suggested Citation

  • Hans Dewachter & Marco Lyrio & Konstantijn Maes, 2001. "Estimation of a Joint Model for the Term Structure of Interest Rates and the Macroeconomy," International Economics Working Papers Series ces0118, Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics.
  • Handle: RePEc:kul:kulwps:ces0118
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    Citations

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    Cited by:

    1. Marco Lyrio & Hans Dewachter & Konstantijn Maes, 2006. "A joint model for the term structure of interest rates and the macroeconomy," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(4), pages 439-462.
    2. Hans Dewachter & Marco Lyrio & Konstantijn Maes, 2004. "The Effect of Monetary Unification on German Bond Markets," European Financial Management, European Financial Management Association, vol. 10(3), pages 487-509.
    3. Dewachter, Hans & Lyrio, Marco, 2006. "Macro Factors and the Term Structure of Interest Rates," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(1), pages 119-140, February.
    4. Marco Lyrio & Hans Dewachter, 2004. "Filtering Long-Run Inflation Expectations with a Structural Macro Model of the Yield Curve," Computing in Economics and Finance 2004 188, Society for Computational Economics.
    5. Hiona Balfoussia & Mike Wickens, 2007. "Macroeconomic Sources of Risk in the Term Structure," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(1), pages 205-236, February.
    6. Duffee, Gregory R., 2006. "Term structure estimation without using latent factors," Journal of Financial Economics, Elsevier, vol. 79(3), pages 507-536, March.

    More about this item

    Keywords

    essentially affine term structure model; feedback interest rate rule; forecasting;

    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
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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