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

Listed author(s):
  • 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)

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.

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Paper provided by Katholieke Universiteit Leuven, Centrum voor Economische Studiën, International Economics in its series International Economics Working Papers Series with number ces0118.

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Length: 60 pages
Date of creation: Jun 2001
Handle: RePEc:kul:kulwps:ces0118
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